Life cover will look after your family when you die, but what if you can't work for an extended period because of illness or an accident? You still have food to buy, bills to pay and a mortgage hanging over your head.
In fact, one estimate is that you are 10 times more likely to become disabled than to die during the life of an insurance policy.
In effect, income insurance protects your ability to earn. Most policies will pay you up to 75 per cent of your net income – either for a set period or until you reach the age of 65, depending on the type of policy you choose.
There are many other variations on this form of insurance, and it's important to understand what's covered. Generally the more generous the provisions, the more expensive the premium – but there's no point buying a policy just because it's cheap when its provisions make a payout unlikely or limited.
Agreed value versus indemnity
Some policies pay you an agreed value per month while others are 'indemnity' products.
With agreed value, you are paid a monthly sum agreed at the time you take out insurance.
With indemnity cover, the income paid is determined at the time the claim is made. This could work in your favour if your income rises, but it could work against you if, as a business person, your income has been declining along with your health.
You can also nominate how long you're prepared to wait for your first payment in the event your income stops. If you can afford to push the waiting period out from 30 days to 90 days – living off your own assets in that time – you'll achieve a big cut in your premium.
Check whether benefits are paid in arrears. A 60-day waiting period may mean you are actually not paid for 120 days.
By the same token a policy that has the payout capped at, say, two years will be much cheaper than one that pays out until you are 65. Just be sure in your own mind that two years is long enough for you to get back on your feet, literally and financially, from an illness or injury.
If you are insuring for only two years, then there's probably no reason to pay a higher premium for an escalation or 'step-up' clause in your payments to cover inflation. But if you want any payout to continue until you're 65, make sure it's indexed – otherwise inflation will erode its value.
Any or own occupation
One of the most important provisions in your income protection policy concerns whether you can work in your own occupation – as a surgeon, say – or in 'any' occupation.
Some policies specify that you'll be paid only if you can't work in any occupation at all; other, more expensive, policies say you'll be paid out if you can't work in your own occupation.
In our example, you may be a surgeon with arthritis and no longer able to wield a scalpel. Under an 'any occupation' policy, you would be expected to gain employment in another capacity rather than call on your insurance. But if you had an 'own occupation' policy, you'd be able to make a claim if you could no longer work as a surgeon.
Sometimes policies combine the two – you'll be paid for the first two years if you can't perform your own occupation but thereafter only if you can't perform any occupation.
Equally, one policy may talk about being able to perform your 'main duties', while another may merely say 'perform your duties'. The latter definition is very general and could lead to problems if you make a claim.
Another grey area is your ability to work 'continuously'. You might be on dialysis two days a week but able to work three days a week – check whether your insurer will pay out in these circumstances.
You also need to be clear about how your policy defines income. Does it encompass your entire salary package or just the cash component?
Does the insurer look at other income you earn, such as investment income and workers' compensation, reducing your payments accordingly?
Income protection cover available through your superannuation fund is usually limited to two years, so you might want to consider a separate but complementary policy with a longer term that kicks in after a two-year waiting period. (That two-year waiting period will substantially lower your premium on the policy outside super.)
Income protection isn't cheap but it is tax-deductible and you should claim it when you file your tax return.
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