Income protection is designed to replace lost income when you are unable to work due to injury or illness. It is aimed at compensating the insured for financial losses caused directly by the inability to work.
Why you need Income Protection
At a younger age, you have many more years of your working life ahead of you, and therefore more earnings to lose should you become disabled. If you do not have disability cover, you will be forced to rely on parents for an income. You will also use your retirement money until it is gone.
Income Protection covers help you do the following:
- Maintain your standard of living.
- Buy groceries and other everyday items.
- Continue to pay your rent/mortgage.
Types of Income Protection
Temporary Income Protection
Temporary disability is more common than permanent disability. Usually, salaried employees would be eligible for between 20-30 days sick leave in a 2-3 year cycle. People who are temporarily disabled for a period exceeding their sick leave will have to take unpaid leave. Temporary disability can cause big income losses.
Where lump sum disability insurance only provides cover for permanent disabilities, income protection can pay out for temporary disability as well.
Permanent Income Protection
When ‘permanency’ is established, your income protection will pay out either until you’re able to go back to work, or until the end of the policy term, retirement or death.
How Income Protection Pays Out
Amount of Cover
The level of income cover is based on a percentage of your income, typically between 50%-75%, but can be increased to 100%. This amount pays out tax-free.
Over-Insurance
The possibility of Over-Insurance must be considered. Income Protection provides a person with insurance against the loss of their earning capacity; it does not put them in a better place financially. If this is allowed, an incentive to claim or to become disabled and avoid returning to work may be created. Applicants are therefore requested to provide details about all current insurance policies so that the insurer can make a proper assessment at the application stage.
Occupational Definition
Life insurers use different definitions of disability to determine whether they should payout:
Own occupation
This measures your ability to perform your particular occupation. Note that ‘own occupation’ does not refer to your current employment or specific job, but rather to your profession, trade, field or business in general.
Own or any reasonable alternative occupation:
This definition measures your ability to perform any occupation for which you are reasonably qualified, based on training, education and experience.
Any occupation:
This definition measures your ability to perform any occupation, irrespective of training, education and experience. This is the strictest definition, and you need to be severely disabled to qualify for benefits under this definition.
Waiting Periods
It is important to remember that income protection policies don’t necessarily payout as soon as a claim is made. You need to wait for a pre-agreed period to pass, known as the ‘Waiting Period’.
You can select to have a waiting period of, for example, 7 days, 1 month and 3 months. If you choose a very long waiting period, you’ll need to be certain you’d be able to get by on your sick pay, or that you have enough savings to cover all your expenses. This is why it is always a good idea to have an Emergency Fund in place. Short waiting periods are more expensive as the likelihood of claiming is higher.
How to choose the right cover
It is important to talk to your financial adviser regularly. Your adviser will help you determine your income protection needs. Independent Financial Advisers are able to compare all available solutions and recommend the one best suited for your needs.
Factors that will affect your application for income protection included:
- Basic information. Things like age, gender, income and occupation will factor into your premium costs.
- Medical conditions. If you have pre-existing medical conditions, such as diabetes or kidney problems, or if you’re a smoker, your insurer will need to know. Sometimes they will require a copy of your medical history.
- Other relevant information. If there’s anything that you think might affect your cover, such as if you’re planning to switch to part-time work in the near future, you should let your insurer know.
Financial independence has two components – Wealth Creation & Wealth Protection. Without the necessary Wealth Protection measures in place, you will not achieve financial independence.
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