Income Protection Insurance protects you by paying an ongoing income if you are unable to work due to illness or injury.
Income protection cover pays an ongoing monthly benefit to protect:
- your lifestyle by replacing your lost salary so you can continue to meet your living expenses and debt repayments, and
- your wealth by reducing or removing the need to sell assets to generate cash.
Without insurance, you may need to run down your savings, sell assets, and/or rely on family or Centrelink for assistance. You may find it difficult to maintain your standard of living or pay for the care and medical assistance you need. This can place extra stress on your recovery.
How it works
You can usually apply for cover of up to 75% of your earnings. For business owners this is income after business expenses but before tax. You may also be able to have an additional amount paid as contributions into your superannuation account and other ancillary benefits to help with your recovery.
The payments are treated as taxable income – although the structure of this will depend on the type of policy you have and the ownership structure.
The amount you receive may also be reduced if you receive payments from sick leave, social security, workers compensation or other legislative sources.
Agreed Value or Indemnity
You can obtain your income protection cover under an ‘Agreed Value’ or ‘Indemnity’ policy.
Under an Agreed Value policy, you will receive the agreed monthly benefit at the time of a successful claim, regardless of the amount you are earning at that time. With an Agreed Value policy you are required to provide proof of income at the time you apply for cover. This may suit you if your income fluctuates over time, you are able to substantiate your income and want peace of mind at time of claim.
With an Indemnity policy, the amount you receive at the time of a successful claim will be assessed on the basis of your earnings in the 12 months prior to the disability. You will need to provide proof of income at time of claim and if your income has reduced you may receive less than expected. This may suit you if you have a stable income and are likely to be able to easily substantiate your income at the time of claim, your occupation does not allow an Agreed Value policy, or you have only recently established your business and do not have two years of financial evidence available. The premium for an Indemnity policy is less expensive than an Agreed Value.
Waiting and Benefit Periods
In the event of a successful claim, benefit payments do not start immediately; a waiting period will apply during which no benefit is payable. The waiting period can be as short as 14 days or as long as two years. When choosing a waiting period, it’s important to take into account any sick leave and related benefits provided by your employer. The shorter the waiting period, the higher the premium.
The maximum period of time that payments continue is called the benefit period. A range of benefit periods are available – some as short as one year, with the longest continuing through to your 65th or 70th birthday. In general the longer the benefit period, the higher the premium.
Income Protection Insurance can be owned either in your own name or within your superannuation fund.
Owning the policy in your own name may allow you to better tailor the cover to suit your individual requirements (e.g. to obtain more comprehensive benefits and ancillary benefits). With self-owned cover, you pay the premium from your cashflow. The premiums are tax deductible to you and benefits that you receive in the event of a successful claim are treated as taxable income and taxed at your marginal tax rate.
You may also be able to purchase your cover in your superannuation fund. This allows the premium to be paid by making contributions to super or simply be deducted from your superannuation account balance so it does not affect your cashflow. The premium is a deductible expense to your superannuation fund and can reduce the tax payable on contributions and investment income. The benefit to you will depend on your superannuation fund.
If additional contributions are made into superannuation to cover premiums, it is important to ensure you do not exceed the limits on how much can be contributed.
The proceeds in the event of a successful claim are paid from your superannuation fund as a temporary illness benefit and will be assessable income that is taxed at your marginal tax rate. You will first need to meet the release definition for superannuation which may be harder to meet than a self-owned policy.
Whilst the concept of Income Protection is quite simple, the difference between a good outcome and a poor outcome comes down to getting the details right. If you are unsure of the quality of your insurance policy or need some help in working out the appropriate cover for you, please contact us for a chat.
McQueen Financial Group is a corporate authorised representative of Total Financial Solutions Limited. AFSL No. 224 954, ABN 94 003 771 579. This information is of a general nature only and does not take into account your investment objectives, financial situation or particular needs. You should not act on any information in this report without first consulting a professional investment adviser in order to ascertain whether the information and any investment decision is appropriate. This information is believed to be accurate however no warranty of accuracy or reliability is given in relation to any advice or information contained, and neither TFSA or its Representatives and officers, agents or employees of either of the aforementioned shall not be held liable for any loss or damage whatsoever arising in any way for any representation, act or omission, whether express or implied (including responsibility to any persons by reason of negligence).