Need to know:
- Income protection insurance gives you a regular income if you can no longer work due to illness or injury
- You can take out the insurance through your super fund or separately
Income protection insurance is available either through your super or directly. This article covers income protection insurance outside super.
In brief, this insurance generally gives you regular income payments if you have:
- become unable to work because of an illness or injury; and
- exhausted your sick leave; and
- have reached the end of your policy's waiting period.
Both types of income protection insurance will replace a percentage of your previous income. If you're receiving any other income (such as government benefits), this can reduce the amount of money you get from the insurer.
What's the difference between income protection insurance in super and retail income protection insurance?
Retail income protection insurance can offer more extended cover and shorter waiting periods than this insurance in super. Another difference is that, unlike income protection insurance in super, these premiums are generally tax deductible. But retail will usually cost more.
This insurance outside super is more likely to be individually underwritten. This means the insurer will take into account any pre-existing medical conditions you have, which could make the cover more expensive. In some cases, the cover you may not be offered cover at all or you may only be offered restricted cover.
This insurance within super is more likely to have automatic acceptance.
Do I need income insurance?
It depends. Income protection policies are designed to meet the costs of 'living', rather than ensuring family members get a payout after your death. So even if you're young and single with no dependents and limited fixed expenses, income insurance is very useful. If you have a mortgage and dependents it's essential.
What is the benefit based on?
If you successfully claim a benefit, it will typically be calculated based on your earnings in the year before your disability. So your payout salary can depend on things such as maternity leave, working part-time or becoming unemployed.
If you already have income protection cover outside your super, you may have 'agreed value' cover. This is where you get a benefit based on a set figure for your salary when you took out the insurance.
Because of concerns about the sustainability of the sector, insurers were banned from offering this kind of cover to new members as of April 2020.
How long will I get paid for?
This depends on how much you want to pay for better contract terms. The more you pay for the insurance, the longer they'll pay you in the case of illness or injury. Policy terms range widely, from two to five years, or up to age 60 or 65.
How much cover do I need?
Here you'll have to do your homework. Income protection covers roughly 75% of your income if you're sick, injured or unable to work. To get the best cover, you'll need to budget your standard costs – such as monthly mortgage or car-loan payments – along with any dependents you want to provide for, plus the cost of managing any investment assets. This will help you decide what level of cover you need.
How much will it cost?
Shop around and compare cover and prices – they differ greatly. Premiums are set depending on:
- age (premiums may increase or cover may decrease as you get older)
- health and pre-existing conditions
- whether or not you smoke
- occupation (for example, a manual labourer pays more than an office worker)
- how long you choose to wait before receiving payment.
Stepped or level income protection insurance premium?
- A stepped premium starts out cheaper, but goes up over time.
- If you plan on sticking with the same provider, a level premium is better in the long term.
- Level premiums are constant but vary depending on your age at entry. They start out more expensive, but after 10 to 12 years of cover, they're the cheaper option.
- If you like to shop around, a stepped premium is wiser. If you like to shop around, a stepped premium is wiser. Note that once you develop a health condition, shopping around may not be possible as this insurance usually doesn't cover pre-existing conditions.
Tips and traps
This list isn't exhaustive. Before committing to a policy you should compare product disclosure statements (PDS). You could also consider getting professional financial advice.
- When taking out a policy, ask these key questions: what's covered? What's not covered? How much will I be paid after a claim? What will the insurance premiums cost now and later?
- Consider a non-cancellable policy. Otherwise companies may reassess your health or other factors on each renewal, possibly raising your premiums or refusing to continue your cover.
- Look for a policy with 'guaranteed future insurability', a benefit that lets you increase your level of cover without further underwriting. This is important if your circumstances change because of things such as buying a home or having a child.
- Offset clauses allow insurers to reduce payouts if you have other income (for example, sick pay or Centrelink benefits). Check the relevant section of the policy for details.
- Some policies pay out if you're unable to do your normal job. Others only pay if you can't do any job for which you're suited by education, training or experience. Look out for policies that pay if you're unable to do your regular job.
Watch those terms: Nick's story
When taking out any insurance policy, check the terms and conditions carefully. You should also check the way the key terms of the policy are defined.
Nick, a farmer from Gloucester, NSW, found this out the hard way.
Nick had an income insurance policy with a large insurer. The policy was fine, but Nick had a not-so-typical income situation, because the money he made varied depending on the success of the farm each year.
When Nick suffered an incident, the company refused his claim because they had defined his assessable income as being based on his taxable income. Sadly, for the year in question, Nick had no taxable income. Instead, his income that year came from a legitimate repayment of money he'd lent to the family company in previous years.
Nick had seen no mention of "taxable income" being the basis of assessing what he would get from the insurer. Luckily, he was able to use an independent claims assessor to help negotiate with the insurer and reach a compromise.