How does Income Protection work?
If you are an employee and you fall ill, your employer might pay you your full pay for a few weeks or months. After that, you would probably have to rely on state benefits. Some employers arrange group income protection insurance for their employees as a perk of their job, which can pay out an income if you are sick. However most employers do not provide Income protection as part of a standard remuneration package.
Many employers will pay for a limited term only ( typically between 3 to 6 months) after which time you will need to rely on state benefits.
Insurance aims to put you back to the position you were in before you suffered a loss. But it does not allow you to make a profit out of your misfortune. So the maximum amount of income you can replace through insurance is broadly the after-tax earnings you have lost less an adjustment for State benefits you can claim. This usually translates into a maximum of, 70% of your pre-tax income.
Income Protection insurance
If you can't work because of illness or disability, income protection insurance pays out up to 75% of your gross income.
You need to estimate how you will cover your normal living expenses if you are out of work.
|Typical living expenses - Family 2 with a 200k mortgage||Monthly cost|
|Mortgage repayments and related life and home cover(20 year term)||€1,100|
|Food at € 350 euro pr week||€1,400|
|Esb, gas, tv, mobiles, etc.||€300|
|Entertainment and holidays and other||€600|
|Total living expenses||€3,300|
Shortfall between state benefits and living expenses €500 per week !
By way of example, a 35 year business consultant, who pays tax at the higher rate of 40%, could get €40,000 cover per annum for approximately €40 per month! ( Based on a deferred period of 26 weeks)
If we broadly estimate that the state will provide 350 euro per week in the above example that will leave a shortfall against normal spending of around 500 euro per week.
The only way to guarantee this shortfall is taken care of is by taking out income protection policy.The most popular income protection policy pays out as long as you cannot return to your existing employment role.
You pay a monthly premium throughout the term of the policy. Cost depends mainly on:
- Your age – at the time you start the policy. Older people are more likely to suffer an illness, so pay more.
- Your sex – gender can have an affect on the premium you pay.
- Your health – at the time you start the policy. If you have existing health problems you might be refused cover or have to pay more.
- Your job – some jobs are more likely than others to contribute towards illness. For example, a bank clerk is deemed to have a very safe job but a deep sea diver runs high risks and so would have to pay more.
- Hobbies and lifestyle – for example, smoking makes you more likely to become ill, so you'll pay more.
- Waiting period – once you claim, there is a delay before payments start. The longer the waiting period, the less you pay.
- If your health is poor or your lifestyle is considered risky, you may be refused cover or have to pay more than normal.
- Check whether you already have protection in place in case you get incapacitated, and for how long that protection would last. For example your employer may have an income protection scheme in place you can benefit from, or you may have a payment protection insurance that covers your mortgage.
- Check whether the policy reduces what it pays out if you receive state benefits or claim money under any other insurance policy.
- Some policies only pay out if you can't do any work, but you would have to be seriously incapacitated for you not to be able to work at all. Others cover being unable to do any work for which you are suited. The best pay out simply if you can't do your normal job, but premiums tend to be more expensive.
- Most policies would pay out until your reach age 65 or when you have chosen the cover to end.
- Check how different occupations are treated. Different insurers put the same job in different risk categories.
- Does the cover increase in line with inflation?
Some advisers inadvertently suggest that critical illness cover (CIC) – which pays out a tax-free lump sum if you are diagnosed with a life-threatening condition listed in the policy – is a cheaper and simpler alternative to income protection insurance. This is not correct.Income protection policies do not require that you have a critical illness in order to pay out. There assessment criteria is based on whether or not you are fit to work in your current position.
But there are lots of common situations when CIC would not pay out – for example, if you had back problems or a stress-related illness. Additionally, not all occurrences of the critical illnesses listed are covered, for example some early stages of cancer are not covered. For more information on this see critical illness policies.
Income protection is an important insurance product that merits serious consideration.Like most insurance it is cheaper the younger you are. Income protection premiums are deductible against tax at your highest rate.