Ask LH: Do I Need Income Protection Insurance?

Dear Lifehacker, I work full time and my wife has just graduated, so she is working full time too. We've got a mortgage but no kids and we thought it was about time to at least investigate life and income protection insurance. After a bit of reading and speaking with people I'm quite confused and unsure! There's stepped and level premium, income protection, life, total and permanent disability insurances . . Where do I begin and what's the best way to get the most value? Thanks, Unsure Insurer

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Dear UI,

Everyone's exact circumstances are different, so we can't give a definitive answer to the question 'Do you need income protection insurance?' For specific advice, you should conduct a professional (and impartial) financial advisor. What we can do is look at the main options so your choice is less confusing.

As with any financial decision, you should shop around before making a commitment. There are plenty of insurance comparison sites, including CCAFP, Choosi, iSelect and Mozo. Just bear in mind that those sites won't necessarily compare every available option; it makes sense to use more than one. You should also check if your bank or superannuation fund provides income protection insurance.

Despite the terminology, the basic aim of most of these policies is the same: to ensure you won't be out of pocket if an unexpected accident means you can't earn your regular wage. Income protection insurance provides a regular payout in lieu of your salary, but usually caps that for a given period of time. Disability protection insurance has a similar approach, but won't necessarily include a time limit. It's rare to get more than 75 per cent of your current income. Life protection insurance provides a fixed sum if you die unexpectedly. That's a more common choice for people who have children; here we'll focus on income protection insurance, since that's more relevant to your question (and a more likely option for a couple with no kids).

Broadly speaking, there are two types of income protection policy policy. Agreed value pays a fixed sum regardless of what your actual income is. Indemnity value policies verify your income at the time of a claim. The latter are generally cheaper (and often offered via superannuation funds).

There are also two payment types: level premiums and stepped premiums. Level premiums remain the same throughout the policy; stepped premiums increase over time. Level premiums will prove cheaper in the long run, but can be more expensive initially (the original level is set based on your age). Rates will vary based on your gender and occupation; unsurprisingly, smokers pay a lot more.

Whatever you choose, there are some key questions to ask:

  • Are there any exclusions or circumstances where the policy won't pay out?
  • How long will you wait for a payout? (Plans with longer waiting periods are cheaper, but that presumes you can cover the gap with savings.)
  • Is the amount paid a fixed sum, or based on your earnings the previous year?

Finally, there's the question of tax advantages. As a general rule, you can claim "income protection, sickness and accident insurance premiums" against your taxable income. That doesn't make them free; it simply reduces your overall taxable income, which in turn reduces your overall tax bill.

Only you can decide if the cost of income protection insurance is worth the peace of mind, or if you'd rather pursue a savings plan. If readers have strong views one way or the other, we'd love to hear why in the comments.

Cheers Lifehacker

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Comments

    Why are income protection, sickness and accident insurance premiums tax deductible? Is it because the payouts you receive if something happens to you are taxed at the normal rate?

    The only reason they are tax deductible is because the payouts are taxed should you ever receive a payout.

      Thanks! :D

    This comment has been deemed inappropriate and has been deleted.

      racist d-bag

    It’s probably worth checking if you already have income insurance or death and TPD insurance. A lot of superannuation plans have this as a default option.

    Don't forget about trauma insurance!

    "check superannuation fund provides income protection insurance" - Whoa - Very Very Bad advice.

    Lets just check this. Have accident and cant work for 12 months. Payment made from insurance fund to superfund the owner of the policy.

    Then how do you get it. Do you meet a condition of release.

    Also NEVER get Income Protection from someone who you dont TRUST. Generally alot of banks are insurance sales men NOT advisors. Know the difference

      Definitely got to agree about the advisor bit.

      It's okay to ask around to get an idea what this insurance stuff is all about but when you get into something more specific than a breakdown of stepped vs level, you need to talk to an advisor.

      Particularly avoid those policies that advertise during day time TV. They assume worst case scenario instead of doing the normal paperwork to find out if someone should pay additional loadings or have exclusions and whatnot. If you're over 50, morbidly obese, smoke heavily and are depressed, maybe those policies aren't so bad. Otherwise, seeing an advisor and getting the right policy will save you an obscene amount of money long term.

      No, you misunderstand. The same company that provides your superannuation often also offers income protection - but they're two separate products/offerings. If you lose your job, your supper company will pay you an income - to your bank account, not to your super fund.

        Tony i think you're misunderstanding what is meant by holding income protection inside superannuation.

        The policy can be held inside super (where the monthly premiums are deducted from your fund balance) or outside where you pay premiums from cashflow.
        While holding Income protection outside of super is preferable, having it inside is better than no cover at all.

          Some supers will have insurance tacked on, typically term and TPD (I think I have something like $100k Term and $100k TPD(any) on mine). It is possible to have income protection offered as part of your super package but it's probably pretty substandard. Long waiting periods, low payout, restrictive terms.

          That is different than paying for your IP out of a SMSF but I don't any advisor would recommend that you rely on those policies if you need IP.

          Sidenote: I'm not an advisor. Everything I'm saying is just information that I've gleaned and may be incorrect as I have no qualifications in this area.

    Firstly, if you’re serious about this, go see an adviser. The cost of getting the right advice is far less than doing it wrong and finding out later, or worse, at claim time. For insurance, generally you won’t be charged much - if at all - to get the advice, as advisers usually get paid a commission from the insurer for writing the policy.

    There are many factors which are very important to consider when thinking of insurance. As a background to my answer, I am a financial adviser and I do provide advice on insurance to clients. Obviously this is not specific advice for anyone, so don’t take it as such.

    Some key points to consider for income protection (IP):

    - benefit period - how long the income protection is paid for. Typically in a superfund with IP, this is 2 years. I almost always recommend cover to age 65 (retirement) - if youre covered for only 2 years how are you going to fund the remaining years? Options usually are 2 yrs, 5 yrs, to 55, to 65, to 70.
    - waiting period - how long you have to be injured before you start to get paid. The longer the wait, the cheaper. Your cashflow situation should be considered when deciding this - how long are you able to live if one or both of you are unable to work. generally the periods are 2 weeks, a month, 3 months, 9 months or a year. take into account any IP you have in super and the conditions thereof.
    - insured amount - as stated above generally max 75% of your income. when you choose either agreed or indemnity, you will still need to provide proof of income, it just depends when you need to do this (application or claim time). one thing to note, insurers generally refund the extra premiums paid if you've insured yourself at a higher level than you are eligible for.
    - To put inside super or not? - with IP, as stated above it’s tax deductible ; generally the cover isn’t as comprehensive inside super; and you will need to satisfy a condition of release to access it. so unless you are flat broke, I’d be thinking of outside super. If you’re flat broke you need budgeting advice too. Look at ANZ money manager (not whom I’m employed by/have any ties whatsoever with. It’s an easy to use free tool).

    General insurance notes:

    - go see a specialist for your industry, if possible - they sometimes have access to special deals like higher insurable amounts and/or cheaper cover etc. I am in this field and we can get our clients (medical professionals) exclusive access to higher levels of insurance, cheaper than other companies who are non-specific. Don’t assume that an insurance broker will be able to get you the cheapest/best cover, shop around. Generating a quote is very quick (i.e. 5 mins) if i have the exact level of cover you're after. Takes longer to find out what cover you need (30 mins)

    Further notes on stepped/level premiums:
    Level premiums do go up, but at a much slower rate than stepped (usually just above inflation). a rep highlighted in his experience that to start to get a benefit out of level premiums, you have to hold the policy for around 10 years (depending on your age). On the quote you can usually see a comparison.

    with your life insurance, you should still consider having some, to cover some or all of the debt on your mortgage, as well as funeral fees etc (some IP policies include benefits for funeral expenses if applicable). The consideration here is if the living partner can afford the debts without huge amounts of financial stress (your tolerance levels here).

    Trauma insurance is cheap for what it gets you - cover for the most common (depending on the policy, of course) hospitalisations - ie cancer, heart conditions, accidents (only some, check the PDS). This is money for initial treatment and ongoing management.
    TPD – many definitions here so be careful. The best is “own” – your own role. Eg a surgeon breaks his hand and can no longer operate due to pain. If its an ‘own’ classification, then all good. If ‘any’, then he can go work as a lecturer or re-train. Bad luck. There are others – ‘general’, ‘house duties’, ‘non-working’, etc. check what you’re covering.
    Another layer of depth – you can ‘link’ policies, e.g. death, TPD & trauma. This is cheaper, but if you claim on one of the linked policies (trauma/tpd) the benefit in all other policies is reduced. There are options to reinstate after a period.

    Hope this helps clarify a bit. Let me know if you want more info. If you’re a medical professional let me know, you're who we specialise giving advice to.

    Again, to make it abundantly clear, this isnt specific advice.

    Simon

      your comment remains helpful years later, many thanks

    If you rely on your income and you don't take out income protection insurance, you're nuts.

      No, like anything else it's risk based.

      I'm young, make 6 figures in a highly marketable career, my wife works as well, we have a low mortgage payment, tons of cash on hand, investment in shares and no other debt.

      Since I don't live paycheck to paycheck, or even month to month, income protection provides me with a very limited amount of risk mitigation. If I took on more debt, or started a business on the side, I would seriously consider some level of insurance here, but other than that I'd rather spend that money investing where I'll likely get a better return.

        Jake as a general comment, unless you have sufficient cash to maintain your living expenses throughout your life you should consider it. As an adviser, part of the value of this protection is being able to continue to accumulate funds to allow you to passively fund living costs - most clients don't want to live on the age pension, if it will still pay anything worthwhile in the future.

        Finally, get an adviser that charges a flat fee for an insurance application, it can save you 30% each year off your premium.

    a. Decide whether you can afford to self insure
    b. If not, see an adviser - too complicated to DIY

    This comment has been deemed inappropriate and has been deleted.

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