An essential component of many financial plans
I’m conscious that the last piece went up on the website only two weeks ago, but with the Budget due on the 22nd we anticipate delivering a hopefully insightful and interesting communication shortly thereafter. So, I’m bringing forward this month’s Technical Note.
Broadly speaking, there are four main areas of financial advice: investments, pensions, mortgages, and protection (no, not the Mafia kind). A lot of time and effort is expended on the first three, they’re the money-makers after all (even a mortgage, which allows you to buy an asset you hope will increase in value – though of course only taxes and death are guaranteed). But protection is the un-loved one of the quartet; it is only ever seen as an unwelcome cost. So today I’m looking at a protection policy that is often overlooked, but one that practically everyone who isn’t retired should have – I’m talking about Income Protection.
As the name suggests this insurance protects your income. If you are employed, your employer will probably try and help if you fall ill and can’t work. It is common for employment contracts to include full pay for, say, three months of sick leave, then half-pay for the next three months, before eventually stopping. The minimum requirement is Statutory Sick Pay, and after that you are at the mercy of the state, but it is very much harder for the self-employed. Every day not working is a day not earning and any prolonged period of sickness could prove very difficult.
So, income protection insurance will pay you a continuing income stream if you have to stop work because of sickness or disability. How much depends on your circumstances, but it is usually up to 65% of your income. It is paid tax free, so can go a long way to meeting the shortfall, though to encourage some attempt to return to work, it can’t be 100% of salary!
The policy is taken out for a fixed term; it is usual practice to set this to your retirement date, because from then on your income will come from your pension. And here is a crucial aspect of this type of insurance – it cannot be cancelled or amended by the insurer regardless of how many claims you make. So, if you have to stop work, the insurance pays you an income until you return to work. At that point you restart premiums to the policy, at the same level as before (unlike car or home insurance) and it continues to provide cover in case you have to stop work again, even if for the same medical condition. There is usually no limit on the number of claims you can make or the length of time a claim can continue, up to the end date of the policy; although, to offer a lower-cost option, some policies set a maximum period per claim, perhaps 12 months.
These policies offer lots of flexibility to meet different circumstances. For example, if your employer is the one above who will pay you in full for three months, then half for three months, you can have cover that will kick in after three months paying 50% of the benefit, then full benefit after the next three months – if you haven’t gone back to work by then. Or you might feel that you’ve got enough resources behind you to last six months without income, so you could have a policy that won’t pay anything for the first six months of a claim. Or you might feel that you could get by on just 40% of your salary, so you could set the cover accordingly. Basically, the more of these features you build in, the cheaper will be the insurance.
Occupation basis – now this is an important point. If you have cover that is on an own occupation basis, it will pay out on a valid claim if you are unable to follow your own occupation. But you could have cover on an any occupation basis. It is cheaper, but will only pay out if your sickness or injury is sufficiently bad to stop you following any occupation. Finally there’s ‘activities of daily living’ (ADL). This is a horrible one, it will only pay out if you are unable to manage two or three of five activities, such as dressing, bathing, feeding yourself, and so on. Naturally, the own occupation one is best, but some insurers will only offer ‘any occupation’ or ADL cover for certain occupations.
Talking of occupations, the cost of cover is also determined by what you do for a living. It ought to be obvious that the tree surgeon lopping off the top-most branches with a chainsaw is at much greater risk of an accident than a Technical Planner who spends his working day behind a cosy desk in central London (ok, it’s not that cosy, but you get my drift). So the tree surgeon’s premium will be higher than mine. Those who travel a lot will pay more, and the deep sea arc-welder working on the North Sea oil platforms? He is totally uninsurable.
You insure your home so that if it burns down you can rebuild and have somewhere to live. If you don’t insure your income you won’t be able to pay the mortgage, so won’t have a home to insure! I’m not trying to scare you, but it makes you think, doesn’t it?
Philip Chandler APFS, CFPTM, Chartered MCSI
Chair of Aspinalls Technical and Investment Committee