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How Does Income Protection Work?

Mitch Ramsbotham

Financial Expert Updated on June 20, 2023

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How can you best protect your income in times of toughness? If you rely on your working salary to cover your day-to-day costs, income protection insurance might give you the peace of mind you need.

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Income protection insurance provides a financial benefit to you, in place of your wage, in the event that you are unable to work due to illness or injury. 

A study by independent researcher Rice Warner in 2017 reported that only approximately 33% of working Australians hold income protection insurance. 

The study also indicated that many of those Australians who held some level of income protection insurance were underinsured, meaning their benefit payment would be unlikely to meet their financial needs if they were unable to work.

If you’re considering obtaining an income protection policy to safeguard your income, this article discusses:

  • What income protection insurance is
  • How does income protection insurance work
  • Why you should consider obtaining a level of cover for your loved ones’ financial security and stability

Income Protection: What Is Income Protection and How Does It Work?

Income protection insurance is a type of personal insurance that helps Australians protect their greatest asset : their ability to earn income.

Income protection cover provides financial assistance in the event that you are unable to work and can’t earn income due to disability caused by injury or illness. 

Income insurance policies are designed to substitute your regular salary so you can continue to pay for your living expenses. 

IP is a monthly benefit/payment that covers a percentage of your usual wage (up to 70%). Note, previous income protection policies may cover up to 85% of your usual salary.

Income Protection Insurance Key Terms

There are several vital key terms associated with income protection insurance, including: 

  • Benefit period: This is the period in which the benefit will be paid (ie. this is how long your income protection insurance pays you for if you can’t work for a period of time). This can range from 12 months to several years. 
  • Waiting period: This is the amount of time you must be off work before you become eligible to make an income protection insurance claim and receive your benefit/payment. This can range from a few weeks to a few months. Usually, the shorter the waiting period, the higher the premium. 

How Is an Income Protection Policy Set Up?

 When setting up an income protection policy, consider the policy type, which can either be:

  1. An Indemnity Value Policy –  The amount you are insured for is a percentage of your salary when you make a claim.
  2. The Agreed Value Policy – This is based on your income at the time of application, locking in a monthly benefit amount, regardless of your current income.

Today, indemnity value policies are the most common type of policy available.

Indemnity value income protection insurance will not cover your entire wage but will cover only a percentage, with most policies only covering up to a maximum of 70% of your pre-tax income. 

Previously, Australians were able to purchase agreed value income protection insurance, which tended to have a higher benefit payment, with the policy based upon an agreed income level at the time of buying the policy, as opposed to paying a percentage on the income level at the time of incapacity. 

Changes made by the regulator, the Australian Prudential Regulation Authority (APRA), announced on 2 December 2019, however, has resulted in agreed value life insurance no longer being available for Australians. 

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Are All Income Protection Benefits the Same?

All income protection benefits are different, with many personal circumstances and policy choices affecting your policy. Circumstances and options include:

  • Age
  • Gender
  • Occupation
  • Lifestyle
  • Current health conditions
  • Smoking status
  • Waiting period 
  • Benefit period
  • Medical history 

What Is Not Covered in an Income Protection Policy?

Whilst income protection insurance sounds like it will replace your income and cover you in all circumstances where you can’t work, this is not the case. 

Income protection insurance policies are limited to paying out only in the event of illness or injury.

Income protection insurance, for example, will not pay out in circumstances where you lose your job or are made redundant, in events such as natural disasters, and other scenarios where you are unable to work due to external circumstances. 

Some policies include virus or disease exclusions. For instance, in the recent COVID-19 pandemic, many people who held income protection insurance could not receive a benefit due to being unable to work due to state-level lockdowns and restrictions. 

Additionally, life insurers and life insurance companies and different income protection insurance covers will have a specific definition of what it means to have a “partial disability” or “total disability”. This is why it is so important to compare income protection insurance policies to find the right one for you. In order to make a successful claim, you must meet a policy’s definitions. 

Knowing what IP covers and what is excluded are critical factors that need to be understood by anyone considering purchasing an IP policy.

Does This Insurance Replace All of Your Lost Income?

Income protection insurance is designed to pay part of your lost income if you cannot work due to a total disability or partial disability caused by an injury or specific medical conditions.

Depending on your policy, your IP benefit could cover between 70-85% of your regular salary.

However – like a life insurance policy – it is also up to you how much income protection cover you want to take out. Your choice on how much cover you want/need will also change your income protection cost/premium price.

For How Long Will Your Income Protection Benefits Be Paid?

The benefit period varies from policy to policy. Most income protection policies may offer two or five years, or up to a specific age, like 65. 

How long income protection is paid out depends on the insurance premium and policy you choose. Usually, the longer the benefit period, the higher the income protection premiums. 

Most individuals automatically get total and permanent disability (TPD) in their superannuation fund. If you were to become totally and permanently disabled, while waiting for your TPD lump sum, remember that you can also get regular, monthly payments from your income protection insurance. 

Can Anyone Get Income Protection Insurance?

Income protection insurance is available to anyone between 18 and 65 years of age.

However, each insurer will have their own terms and conditions related to eligibility criteria. Just because you fit the general criteria of acceptance in terms of age, other factors may exclude you from obtaining insurance.

Not all options, benefits, and sum insured levels are available online.

You can purchase income protection insurance:

  1. Through your super fund
  2. Directly from a life insurer
  3. From some financial advisers
  4. From My Money Sorted Insurance Partners

When looking to purchase income protection insurance, it’s important to compare income protection policies – including benefit periods, tax deductible options, waiting periods and costs.

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How Do You Make a Claim?

Making an insurance claim under your income protection policy involves contacting your provider (whether this is your super fund, a financial adviser or insurance company)

Most insurers have an online claim process. After making initial contact, you submit your claim form and supporting documentation online. This can include:

  • medical reports and certificates
  • details of your employment (including hours and physical requirements)
  • payslips and financial statements

Your insurer may ask for permission to contact your doctor about your claim. You may also have to go to an independent medical examination with a specialist, who can then report to the insurer. 

If illness or injury continues to affect your ability to earn an income, you may need to have regular assessments and complete progress claim forms. 

Should your claim be deemed successful, as is the case with 94% of income protection claims submitted, you will receive a benefit after the expiration of your waiting period.

As some income protection policies allow you to claim a tax deduction on the premiums, any payment received under an income protection policy must be included in your tax return.

Is Income Protection Insurance Useful for You?

Income protection may be useful for you if you:

  • are a small business owner or self-employed, as you may not have annual or sick leave. 
  • have dependents or family members that significantly rely on the income you earn
  • have debts, such as a mortgage, that you need to continue paying even if you can’t earn an income

In deciding whether income protection insurance is right for you, it is always best to obtain financial advice from a financial adviser.

Consider whether your family would be able to survive without your wage and make ends meet.

Before purchasing income protection:

  • The insurance policy’s relevant product disclosure statement (PDS) should answer FAQs on terms and conditions and eligibility criteria.
  • You should also check the target market determination (TMD) if it is applicable to your financial situation.
  • Check a financial adviser’s financial services guide (FSG) to view their insurance-based qualifications

Still not sure where to start, or want help securing the right insurance faster? 

That’s okay!

Many people may be unaware of this…but just like you, 41% of Aussies intend to get financial advice rather than going it alone, according to an Australian Securities and Investments Commission (ASIC) report.

You can reach out to My Money Sorted to guide you for free before you seek professional advice from an insurance expert!

When you book a call with My Money Sorted, you’ll:

✓ get a better understanding of your money matters

✓ have an idea of your money goals

✓ be matched with the right insurance expert who can help simplify your search for an insurance policy that fits your needs

My Money Sorted is your stress-free pathway to getting ahead with your money. Here’s what your journey will look like:

Step 1: Start off with a quick money matters session with My Money Sorted

Step 2: Get matched with a Insurance Expert that’s right for your money situation

Step 3: Take the first step towards getting the protection you need with a clear and sound roadmap prepared by an Insurance Expert

It’s that easy!

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FAQ

How Much Does Income Protection Insurance Cost in Australia?

What you pay for income protection is based on a number of factors including age, smoking status, occupation, benefits you choose etc.

However, the below hypothetical scenario can give you an estimation of the cost of income protection insurance.

The below cost is based on Zara: a 35 year old, non-smoking woman.

  • Zara wants the maximum benefit available to her (70% of her $80,000 annual income)
  • Therefore, Zara would receive approximately $4666 per month if she were to make a claim
  • Zara’s IP premiums would cost approximately $33-42 per month

References

  1. Income Protection Insurance

https://moneysmart.gov.au/how-life-insurance-works/income-protection-insurance

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