Arranging your own protection

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Arranging Your Own Income Protection

The main way in which you can make sure that you would still have enough to live on if you could not work because of illness is by taking out insurance.

There are 3 types of policy to consider, which are described below.

Income protection insurance

Income protection insurance (formerly called 'permanent health insurance') replaces part of your income if you are unable to work because of illness or disability. Since 6 April 1996, income from these policies has been tax-free.

50% of your income

Typically, the maximum income you are allowed to replace is 50 to 65% of your income before tax (your gross salary if you are an employee or your taxable profits if you are self-employed). Usually this limit includes replacement income from all income protection policies, pension schemes and so on.

Often it also includes benefits you are entitled to claim from the state. You won't be able to claim more than the permitted maximum, so it's important to work out the limit which applies to you and to make sure you don't pay extra for cover you wouldn't be able to have.

The replacement income is normally paid until retirement or until you recover, whichever comes first. But some budget policies limit the maximum pay out period to, say, two or five years. This makes the plans cheaper, but would leave you unprotected if you suffered a prolonged illness or permanent disability.

Cutting the costs of income protection

There's no doubt that income protection insurance is expensive, but there are various steps you can take to cut the cost.

You choose how long after the onset of an illness you want the policy to start paying out. This is called the 'waiting period' or 'deferred period' and can normally be 4, 13, 26, 52 or even 104 weeks. Choosing a longer waiting period reduces the premiums you pay. You can fit the waiting period to your other resources, for example a sick-pay scheme at work, or savings.

When choosing the amount of income you want the policy to provide, you do not have to opt for the maximum allowed under the policy rules. You can choose a lower amount. Work out what level of spending you need to cover.

The pay out can be at a flat rate. Alternatively, you can opt for an increasing income - worth considering, since otherwise inflation will erode the value of the income. There are two aspects to this: first, you want to know that the amount you would start to get if you made a claim is being increased each year; secondly, once an income is being paid, you want to be sure that it will be increased. The drawback is that the premium increases each year along with the cover.

What is inability to work?

Watch out for the definition of inability to work used by the policy. There are 3 possibilities:

• Inability to do your own job.
• Inability to do a job for which you are suited by training and experience.
• Inability to do any job.
  

The last definition is the broadest, reducing the likelihood of your having a valid claim, so you should expect to pay less for a policy using this definition. The first definition is the narrowest and usually the most expensive. Some policies change the definition after, say, two years. For example, you might be covered for the first two years if you can't do your normal job, but then payouts cease unless you are so ill or disabled that you can't do any job.

At one time the premium you paid at the outset of the policy was guaranteed to continue for the whole lifetime of the policy (assuming the level of cover was unchanged). This type of policy is now very rare, and nowadays premiums are usually reviewed every five years and can be increased if the insurance company finds that claims by its policyholders are higher than it had expected.

Your hobbies

Expect additional premiums or restrictions on cover if you enjoy flying, rock-climbing or other sports which insurers consider dangerous · your lifestyle Smokers are often charged more, you'll usually have to give details of how much alcohol you drink regularly and insurance companies want to find out whether there's a risk of your contracting AIDS.

The chosen level of payout

The higher the income you choose, the higher the premiums.

The waiting period

The sooner you want the payout to start, the higher the premiums.

Other policy options

For example, you pay more for increasing policies than ones paying out a level benefit.

Income protection policies can either be pure insurance, in which case your monthly premiums go directly to buy the cover you've selected, or they can be investment-linked. With the latter, your monthly payments are invested and the cost of the insurance is paid from your investment fund. Your plan is reviewed, typically, every five years. If the investments has grown by a target rate or more, cover continues at the standard price (and you might receive a cash sum when the policy comes to an end). However, if the investments have not grown as well as expected, your premiums are increased or the cover might finish earlier than you had originally intended.