What is Income Protection Insurance and how does it work?

Income protection insurance: safeguarding your biggest asset.

Let’s be honest – no one likes to think about what might happen if they couldn’t work. But life is unpredictable. Illnesses, injuries, or accidents can happen when you least expect them, and without a steady pay cheque, covering everyday expenses can quickly become a challenge. That’s where income protection insurance comes in.

What is income protection insurance? 

Simply put, income protection insurance is a type of insurance that pays you a regular benefit if you’re unable to work due to an accident, injury or illness. It’s designed to help you keep up with bills, mortgage repayments, groceries, and all the other costs of living while you recover.

Why consider income protection?

“We don’t hesitate to insure our home or car,” says Private Wealth Partner Andrew Mackenzie, “But what about our most valuable asset: our ability to earn an income?”

Without your regular paycheck, covering daily expenses, rent or mortgage payments, and even groceries can quickly become difficult. 

Now imagine being out of work for months due to a serious injury or illness. Your sick leave might cover you for a short while, but what happens after that?

That’s where income protection comes in: this type of insurance can provide up to 70% of your pre-tax income, giving you some breathing room while you focus on getting better.

Who should get income protection insurance?

Income protection insurance is especially important if you:

• Rely on your income to cover household expenses
• Have dependents relying on you financially
• Are self-employed or a contractor without access to sick leave benefits
• Have debts like a mortgage, personal loans, or credit cards to repay

Speak to a financial adviser if you think you might benefit from protecting your income.

How does income protection insurance work?

If you make a claim and it’s approved, income protection pays you a monthly benefit after a predefined waiting period (which can range from 14 days to several months). You can choose how long you want the benefit to last – from two years to up until retirement age, depending on the policy.

How to choose an income protection policy?

Selecting the right policy involves more than just picking the cheapest option. Here are some key factors to consider:

Understand your financial needs.

Creating a financial plan or a detailed household budget is an essential first step to choosing an appropriate income protection policy.

Any budget worth its salt will reveal how long you could go without income and continue to manage your regular payments like bills, rent/mortgage and groceries. 

To fully understand your needs, it should also account for any other possible benefits and financial support you can access. 

This might include other total or permanent disability or trauma insurance policies that you hold (potentially via a superannuation fund, for example). It’s also worth accounting for private health insurance which may assist with medical costs or treatments. And don’t forget to include any private support you can reasonably expect from friends or family while you recover.

Deeply understanding your household income and expenses is central to selecting a good policy. So it’s worth speaking to a financial adviser who specialises in risk, when you’re ready.

Different kinds of income protection policies.

Indemnity value policies: Your benefit amount is based on your income at the time of any claim. These policies are generally cheaper but if your income has decreased since you took out the cover, you may be surprised to receive a lower-than-expected payout.

If you have variable income, insurers will use your average annual earnings (over a period of time deemed appropriate for your occupation) to determine your benefit value.

Agreed value policies: Since March 2020, new agreed value policies are no longer available for clients. But if you have an old agreed value policy from prior to this date, you can continue to hold it.

With an agreed value policy, your benefit is a fixed amount that was agreed upon at the time you applied for the policy. These policies are typically more expensive, but can offer greater certainty for those with variable income. 

Waiting periods for income protection.

When selecting an income protection policy, it’s also important to consider the length of time you must wait before benefits start being paid.

Waiting periods vary widely – from 14 days to two years. If you are able to return to work before your waiting period elapses, you will not qualify for a benefit. So it’s important to consider how long you could manage without your regular income – shorter waiting periods cost more but pay out sooner.

 It is also important to note when selecting a waiting period that income protection policies will usually pay 30 days in arrears (e.g. if you select a 90 day waiting period, it will actually be 120 days until you receive a payment).

Benefit periods for income protection.

The Benefit Period for a policy refers to how long the insurer will pay you, once you’ve passed your waiting period and remain unable to work. 

Most policies offer a benefit period for a set number of years (e.g. pay you for 2 or 5 years) or up until you reach a specific age (e.g. when you hit 65). Broadly speaking, the longer your benefit period, the higher your premiums.

Terms, conditions and exclusions.

Before signing on the dotted line, be sure to read the full terms and conditions of your chosen policy. Check the insurer’s Product Disclosure Statement for all definitions and any exclusions to your individual policy.

Be mindful that different insurers and policies have their own definitions of “partial or total disability” that must be met before a claim is made. You may also find some policies include exclusions you’ll need to consider carefully before accepting.

It’s worth noting that if an insurer hasn’t asked for your medical history, their policy may have more exclusions or limiting policy definitions.

Applying for income protection: what you need to tell your insurer.

When applying for or changing your income protection insurance, honesty is essential. Insurers typically ask about:

• Your age, occupation, and income
• Medical history and current health
• Lifestyle factors (like smoking, drinking habits, or risky hobbies)
• Any existing insurance policies

Failing to disclose relevant information can lead to claim denials later. If you’re unsure what’s important, your financial adviser with specialist risk knowledge can guide you through the application process.

In fact, our team at Kearney Group can help you through the entire risk process – from building a household budget through to selecting the right policy for your needs, to lodging your application and even helping you through a claim.

Making a claim on income protection insurance.

If you need to make a claim, it can feel overwhelming – but you don’t have to go it alone. Start by speaking to the financial adviser or risk specialist who helped set up your policy. They *should* support you through the claims process, liaise with your insurer, and help you to provide all necessary documentation.

Generally, you’ll need to provide:

• Medical certificates detailing your condition and how it affects your ability to work
• Evidence of your pre-disability income (such as payslips or tax returns)
• Completed claim forms provided by the insurer

Having professional support can make the process smoother and faster, helping you access your benefits as soon as possible. It’s also a weight off your shoulders during difficult times and allows you to get back to what really matters: getting fighting fit and healthy.

Is income protection tax-deductible?

Good news! In Australia, a portion of the premiums for income protection insurance are generally tax-deductible if you take out the policy independently (not through superannuation). However, any benefits paid out are typically taxable.

As with all things finance, the devil is in the details so check with your financial adviser or accountant for specific advice.

What’s better: my super fund’s income protection or a private policy.

Many super funds offer income protection as default or optional add-on (also known as group salary continuance, or GSC). Check with your super fund to see if you already hold GSC.

Holding income protection within your super fund can be convenient since premiums can be lower on group policies, and can be paid from your super balance.

However, there are some trade-offs to consider. Typically the default income protection policies in super funds have few features and lower benefit amounts. Plus, paying premiums from your super balance can impact your retirement savings.

By comparison, policies held outside of super are often more expensive, but typically offer a wider range of features and benefits, and allow for higher cover.

Final thoughts.

Income protection might not be the most exciting thing to think about, but it can make a world of difference when life throws you a curveball. It’s about peace of mind – knowing that if the unexpected happens, you can still meet your financial commitments and focus on recovery.

As with any insurance, it’s important to understand the details of your policy and get advice tailored to your situation. Not all policies are created equally, and what works for someone else may not suit your circumstances.

If you’re unsure where to start, chatting with a financial adviser can help you navigate the options and find the right fit. After all, protecting your income is really about protecting your lifestyle and the people who depend on you.