Income protection explained

To help you decide if income protection insurance is right for you, we've compiled a short guide that explains what it is and how it works.

What is income protection insurance?

Income protection insurance is designed to replace your income with a monthly payout if you are unable to work due to injury or illness. It is sometimes referred to by its abbreviated form - IP insurance.

The maximum amount of income you can recover through this type of insurance policy is broadly your net monthly earnings (i.e. your earnings after tax) less an adjustment for the state benefits you can claim. This usually equates to a maximum of 50-65% of your gross monthly earnings (i.e. your earnings before tax).

Policies start to pay out after a deferred period, which is usually 4-52 weeks duration, and continue to pay out until you return to work or the policy expires (usually when you reach retirement or at the end of a fixed period). Normally payouts are tax free.

There are two main types:

Short Term (Accident Sickness and Unemployment) (Payment Protection)
These are plans that pay out for 12-24 months, and are designed to be low cost, simple and available to the majority. They usually exclude things like pre existing medical conditions, back problems and stress but can be extended to cover unemployment.

Premiums are often based on age, but are not affected by the type of employment of your medical history.

Long Term (Permanent Health Insurance)
These are plans that focus on health not employment and provide you with a long term income and pay for as long as you will require usually right up to your normal retirement age. To do this they have to look more carefully at your medical history and type of work and the risks are reflected in your premium.

Why do I need it?

Income protection insurance may be suitable for you if:

You would struggle to maintain your monthly financial commitments in the event that you are unable to work due to illness or injury.
You have dependents.
You are self-employed

Is it really necessary? What about State benefits?

State benefits provide limited support and some benefits require a prolonged period of incapacity before you become eligible.

You can visit the Directgov website to find out more about benefits for the ill and injured^†.

Is payment protection insurance the same as income protection insurance?

No. Payment protection insurance provides cover for personal loan repayments and/or minimum monthly credit card repayments if you are unable to work due to accident, sickness or unemployment. It is sometimes referred to by its abbreviated form - PPI - and tends to offer short term cover only, usually for 12 - 24 months.

Is mortgage protection insurance the same as income protection insurance?

No. Mortgage payment protection insurance pays out an amount equivalent to your monthly mortgage payment if you are unable to work due to accident, sickness or unemployment. It is sometimes referred to by its abbreviated form - MPPI - and tends to offer short term cover only, usually for 12 - 24 months.

Read our mortgage protection guide for more information about MPPI.

What types of income protection (Long-term PHI) insurance are available?

There are three main types of policies available:

Guaranteed policies

With this type of policy the premium you pay stays the same for the duration of the policy term - whether it is 5 years or 25 years - unless you choose to increase the cover available. If you do increase your cover then your premiums will increase pro rata. This type of policy tends to be the most expensive initially but can work out cheaper over the medium to long term.

Reviewable policies

Reviewable policies are reviewed by the provider at regular intervals, often annually, meaning that the premiums you pay will increase. Although reviewable policies tend to start off cheaper than guaranteed policies they can work out more expensive over the medium to long term.

Age-related policies

With this type of policy your premiums will increase every year in line with your age, however you will know in advance how much the increase will be. As their cost is unaffected by gender, lifestyle or occupation age-related policies are often a popular choice for people who pay higher premiums due to being a greater risk to insure e.g. women, smokers and those with high risk occupations.

What cover can I expect?

Aside from a regular monthly payout, cover may also be available for:

Terminal illness

If you are diagnosed with a terminal illness that is likely to lead to your death within a 12 month period then your insurer will allow you to take a lump sum benefit equivalent to the benefit that would normally be paid over a set period e.g. six months. Depending on the policy this cover may be included as standard or available as an ‘optional extra’ for an additional premium.

Death

The majority of income protection policies do not offer a death benefit, however if cover is available then the insurer will pay a lump sum based on your monthly benefit amount.

Waiver of premiums

In order for your income protection policy to remain valid you will need to maintain your premiums even when you are unable to work due to illness or accident. Waiver of premiums provides cover for your premiums during the period you are incapacitated. Normally it is available for an additional premium rather than included as standard.

Rehabilitation

Insurance companies are starting to recognise that rehabilitation is an important factor in getting policyholders back into work therefore they may offer additional support such as retraining and assistance with finding a new job. Some insurers will also pay a partial benefit if you go back to work part time.

Remember! Cover can vary significantly between providers, so it's important to check exactly what level of cover you are getting from a policy before you buy.

What deductions can I expect?

If you fall ill or are injured an income protection policy will pay out up to the benefit limit but only after deducting:

Sick pay or wages.
Income from self-employment.
Any pension payment that starts on the date of incapacity.
Insurance payments from another policy, such as PPI policy.
Other types of income, such as dividends from shares etc.

Usually your payout will not be reduced for:

Social security benefits
Means tested benefits, such as income support.
Investment income.

In the next part of our guide we look at arranging income protection insurance in more detail.

Arranging income protection insurance »