Income Protection Insurance Guide: Definition, Coverage, Suitability, Pricing, Taxation
One of the most important things in your life as an employed person is your income.
The term “employed” as used here can either mean employed by someone or self-employed. Both are forms of employment.
Hard work pays. And when you get paid for your hard work, you definitely enjoy it.
This is the fruit of your labor. It is your income and you have every right to enjoy it.
As much as you can go out for dinner, shopping or indulge in some way, your bills cannot be ignored. And key among them is your housing, whether rent or mortgage.
Food is equally important and so are the fees for your children’s schooling if you have kids. You might also be pursuing an education yourself.
Basically, there are expenses which have to be taken care of.
Keeping with the cycle of working, getting paid and settling bills, what if your income suddenly disappeared?
This is not a case of negative thinking. It is a call to think about the future.
PROTECTING YOUR INCOME
You obviously wouldn’t want such a situation in your life. You want everything to go well. Your employer to increase your pay.
If self-employed, you want more business so as to expand and have increased sales.
All this is great and even necessary to think about and look forward to. Still, in the midst of all of this, you need to plan for some not-so-good eventualities in case they show up.
One eventuality is illness or disability which can cause you to be unable to work. Being unable to work means potentially being unable to earn an income.
This means that you won’t be able to settle your bills. And this is not a good situation to find yourself in.
Consider the below statistics:
Income Protection Insurance
Disability can happen. In a split of a second, an accident can result in a disability.
A seemingly small disease can get worse and become a more life-threatening condition. All this time, your bills will still be accumulating.
To stay safe, you can protect yourself using an insurance policy called income protection. This is also known as salary continuance and is used when someone gets sick or injured and is unable to work. This insurance policy will pay you on a monthly basis to sustain you during this time.
Income protection insurance can especially be great if you are self-employed or a small business owner.
The risks involved in such cases are high since you are the one depended upon by the business. If you are not there, the business stalls.
This is different from large corporations where structures and processes have been established. The exit or absence of one employee easily gets sorted and no much harm is experienced.
But an income protection insurance policy is not just for the self-employed.
The fact that employees have a constant flow of pay makes it easy for them to pay their premiums. They are also able to negotiate lower premium payments.
The amount of premium paid is however depended on many factors as will be discussed later in this article.
WHICH TYPE OF POLICY IS BEST FOR YOU?
It’s important to have some basic understanding of the options available before going into discussions with your adviser.
Although he can explain everything and answer all your questions, being informed gives you an opportunity to know what to look for.
There are two main types of income protection insurance policies. They are largely different on the basis of application requirements and payment amounts.
However, there are still other differences as you will see below.
Indemnity Value Income Protection
This is the more common income protection insurance policy. It is cheaper than the other alternative. Many people apply for it and enjoy how it works.
Because of how it has been designed, application is very easy.
There are some insurers who have even provided a means for people to apply using their phones.
This means that there is no requirement for things such as medical tests.
Here is what distinguishes this policy from the other option:
1. No proof of income amounts required during application – this makes these policies very popular due to the ease of application. All that you will be required to do is state the amount of income you earn.
This will be used to calculate the premium amount you will be paying. Even though you are not required to give proof of your income amount, you will do best to be honest.
The time of proving the income will come later—when you make a claim for payment.
2. Monthly benefit payment is assessed and agreed upon at the time of claiming – when the time to claim comes, you will be taken through a process of finding out the truth of your claims during the application process.
If you are employed, you will need to provide pay slips as directed by the insurer.
This process can be lengthy and tiring for some people. You will have to provide whatever the insurer needs so as to assess the amount to be paid as benefits.
3. Benefits paid are the lesser of 75% of your pre-disability income or monthly income insured – as the benefits are being calculated, there are two choices which the insurers can use for payment. Either 75% of your income amount before the disability or the monthly income insured.
The amount which is lesser than the other is what will be paid out. This can be a bit disappointing in case the amount decided upon is lower than what you expected.
This often happens if your salary has reduced since the time you applied.
Agreed Value Income Protection
This is the other option for you while looking to insure your income.
Although the same purposes are served as with the indemnity option, it goes about it a bit differently.
This option also tends to be quite expensive and not as popular as the indemnity policy.
Here are some of the ways it distinguishes itself:
1. Income amount is proved during application – to apply for this policy, you have to avail yourself to the insurer with evidence of the pay amounts you currently receive.
This will be part of the process and the figures will help determine premium amounts.
For this reason, those applying for it are fewer. It is also more expensive due to the amounts to be paid as benefits. The next point explains this further.
2. Monthly benefit payment is assessed and agreed upon during application – as the name of this policy indicates, the amount to be paid is agreed upon at the time of application.
Take note that the insurer will have to stick to this figure since it is what has been agreed upon.
As such, the insurer has to calculate the premium amounts which will provide the benefits amount. This makes the policy more expensive since the insurer has to cover himself.
That only means higher premium payments.
3. Provides certainty in the amount to be received after claim – once the amount to be paid as benefits is agreed upon, there can be no change. That is the amount that will be paid.
This makes the policy a good choice for someone who wants predictability.
This helps in planning for those situations in which you might be unable to work. If you know that you will get a certain amount of money which will be enough for your expenses, then you are at peace.
HOW MUCH DO INCOME PROTECTION INSURANCE POLICIES COST?
This is a central talking point in the discussion about insurance policies. They are definitely an expense and you want to know how much it will cost you.
The first thing to understand is that there is no specific answer to this question. Insurance policies differ from one another depending on how they have been designed.
As much as there are only two major types, there are things one insurer will consider while the other one won’t.
That aside, there are some common factors which determine the cost of income protection policies. Here we will briefly discuss 7 factors.
From these, you will be able to know whether yours will be cheaper or expensive.
Percentage of Income to be Covered
In the discussion which you will have with your insurer, you will be the one asking for certain benefits. The insurer will then advise on the possibility or impossibility of your request.
Alternatively, you can present your information and request to know how much can be insured.
Either way, your needs will be considered and they are at the center of everything. If your needs are more, then you will be required to pay a higher premium.
Note that you cannot have a policy which will pay more than your gross salary.
This might end up being a case of you benefiting from your illness or injury. More than that, it will simply be against insurance policy standards to offer you such a payment.
For the agreed value policy, you will have some room to negotiate a higher benefits payment if that’s what you want.
Just keep in mind that this is determined by your current income. If your pay cannot sustain it, then you may not get it.
The waiting period is the time it takes for the coverage to begin or the claim to be made. It is a duration of time which is agreed on by you and the insurer.
This period is usually part of the terms of the policy. It ensures that you cannot claim benefits within a certain time frame.
Depending on what you want and what is agreed on, the waiting time will vary. It can be anything from 3 months to even 1 year.
In health insurance for example, this is implemented to prevent cases where policyholders claim treatment for a disease they had before the application of the insurance plan.
In some cases, some people can attempt making a claim immediately or soon after the coverage plan has began.
Where the waiting time is longer, then the premiums will most likely be of lower amounts.
The shorter the waiting time, the higher the premiums.
Age and Gender
Your age and gender are other factors which will determine the cost of your income protection insurance policy. This is informed by the different aspects of life between men and women.
For example, women have generally been known to take up more insurance products compared to men. This can be traced down to pregnancies and conditions relating to their nervous systems.
This points to more vulnerability. The more vulnerable you are, the higher the risk.
In other cases, men might be the ones paying higher premiums because they are more likely to be involved in accidents than women. Accidents are responsible for 10% of the cases of disabilities.
The age factor is an obvious one. The older you are, the more at risk you are to become sick. The younger you are, the less the risk. The elderly often have higher premiums because there are many different diseases they may suffer from.
The younger ones on the other hand, are more healthy and strong, unless they have a medical condition.
Range of Illnesses Covered
Since these policies cover the inability to work as a result of illnesses or injuries, there are definitely some illnesses which won’t be covered.
These are those which can be ruled to be as a result of irresponsible behavior.
An example is a case of sickness caused by the continued use of drugs. Drug use has its effects. In many cases, especially in extreme cases of drug abuse, things can get out of hand.
Such conditions can be either short-term or long-term.
Although short-term conditions can also be dangerous, it is the long-term conditions that will often stand out.
Some diseases which can be caused by drug use include heart disease, cancer, lung disease and even mental illness.
There is one particular drug, though considered a social drug, that can be very dangerous. In fact many insurers will question you about it. That drug is nicotine.
This is found mostly in cigarettes and many insurers will ask you whether you smoke.
Your health status is very important to the insurer. This is because your health determines how soon you can become unable to work.
During application, especially for the agreed value policy, you will have to undergo a medical test.
What the results will indicate is what will be used to determine the premium.
The healthier you are, the less vulnerable you are to diseases. This means cheaper premiums.
Some of the diseases ranking highly as dangerous are those relating to your mind and heart.
Your occupation will also play a role in determining how much you pay as premium. It is your daily work that exposes you to risks and so what you do daily counts.
The manual and more specialized jobs will attract higher premium payments.
For manual jobs, the number of risks involved are many. For example, you may be working in a factory where you are involved in cutting glass.
What happens if you one day get injured for handling the glass without special equipment?
Some professionals can also be considered high-risk individuals. Surgeons are one of them. Although they don’t do manual jobs, they operate in highly risky environments.
Some surgeons work for many hours as they perform surgeries. Where the surgeons are few, the chances of stress-related conditions like anxiety and depression can be experienced.
Your lifestyle can also determine the cost of your cover. For example, you may be a fan of surfing on the beach. As much as you may be experienced, there are dangers from waves.
Your chances of dying in the sea are higher than someone who spends his free time listening to music.
At the same time, some sports make you more vulnerable to hurt than others. For instance, your free time may be spent practicing boxing and mixed martial arts.
These can cause bodily damage. Compare this with a sport like chess which only engages the mind.
Since covers look at the level of exposure to risk, the more risky your lifestyle, the more your cover will cost.
For Income protection insurance, the one paying the premiums determines whether the benefits will be tax deductible.
If you pay the premiums yourself, then the benefits will not be tax-deductible. This is because you paid taxes from your income. As such, taxing the benefits payout would result in double taxation.
On the other hand, if your premiums are being paid by your employer, the benefits from it are taxable. This is because the payments never went through any form of taxation.
When the payout is done, this will be a source of income for you.
This is why it will be taxed.
You might have shared the cost of the premium with your employer. In this case, the taxes deducted will be dependent on the percentage contributed by both parties.
For instance, you may have contributed 50% while your employer contributed the other 50%. When the benefits are paid out, 50% of the payment will be taxed. This represents the portion paid by your employer.
Since you’re not in complete control over your life, do the wise thing. Insure your income and live with some peace of mind.
Then you’ll be safe despite any disruptions in your ability to earn an income.
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