Having a safety net is essential to protect yourself from financial shock. While many of us have savings in place and a family to fall back on, new research has shown an alarming number of Brits aren’t protected in the event of the sudden loss of income.
In an interview with the FT Adviser, Raluca Boroianu-Omura, Head of Health and Protection for the Association of British Insures explains, “The protection gap in the UK is one of the largest in Europe. Millions of households could be left seriously exposed if the main earner were unable to work, and the family forced to rely on state benefits to get by.”
Imagine a scenario where you’re suddenly made redundant or fall ill and are unable to work. Without savings or a network to fall back on, such a financial shock could leave you devastated, it’s easy to see how things can spiral out of control.
Income protection insurance gives you a lifeline and while it doesn’t provide you a lump sum, it can pay you a regular income of up to 80% of your salary. The product has a reputation of being complex, and being named something uncomfortably close to the notoriously mis-sold payment protection insurance doesn’t help. But income protection is not as complex as it may seem and a legitimate and effective form of protection.
At Budget, we’ve written a handy guide on all you need to know about protecting your income, building a safety net and mitigating risk.
Is income protection insurance PPI?
No, income protection insurance protects you when you suddenly fall ill or become redundant and are no longer able to work, whereas PPI is insurance sold with credit cards or loans to provide cover against payments if you’re ill or unemployed and can’t make the repayments.
How does income protection insurance work?
If you become redundant or critically ill you’ll be paid a regular replacement income. The payments are based on how much you earn and typically range from 50 – 80% of your current salary.
As with any insurance product, it’s essential to check what the insurance will cover beforehand. Not all income protection policies are the same and it’s worth doing the extra research to find a policy that’s right for you.
There are three types of cover available to choose from:
- Accident, Sickness and Unemployment (ASU)
- Accident and Sickness only
- Unemployment only
Short term vs long term protection
You can choose to get income protection insurance on a short or long-term basis, see below the differences between the two.
Short term policies
You’re covered for a shorter period which is typically fixed and lasts up to a year. It’s there to provide safety against your lower income levels while you’re off ill or redundant until you can work again.
Long term policies
Long-term policies provide protection all the way up to retirement and cover you for more serious, life-long and degenerative conditions or sudden debilitating medical issues such as strokes or heart attacks.
What cover options are available?
There are two options common with income protection insurance, these are:
The amount of cover is fixed when the policy begins and won’t rise with inflation rates
Inflated linked cover
The amount of cover increases with inflation each year.
You are also able to choose which type of premium you would like:
Your premium will not change (unless you choose inflation linked cover).
The premium is calculated by the insurance provider based on several factors, which is reviewed throughout the course of the policy. Payments aren’t guaranteed to stay the same.
How much will your income protection cost?
With income protection, it’s common for insurance providers to group it into four or more types of risks. This can be a significant factor in determining the premium of your insurance, although other factors are considered including your health and whether you smoke. The four main classes are:
- Class 1 – Professional, executive, managerial, clerical, administrative or office duties.
- Class 2 – Skilled occupations which involve some manual duties (e.g. engineers)
- Class 3 – Skilled manual workers and semi-skilled occupations which include some manual duties (e.g. plumber or teachers)
- Class 4 – Semi-skilled workers, where majority of obligations are manual, some unskilled professions. (e.g. bar staff or builders)
Your insurance provider will be able to provide more guidance on which class your occupation fits into.
Alternative safety nets – emergency fund
Insurance isn’t the only way to protect yourself from financial shock. If you have the resource to start saving, building an emergency fund can help mitigate the risk and give you another lifeline to fall back on.
With the proliferation of technology, there’s plenty of ways to make saving more efficiently while you don’t have to consciously think about it. For instance, there are apps available which round up purchases and invest the extra into a savings account, access your bank accounts on the go, categorise spending and calculate savings.
Another good method is to set up a standing order into your savings account, funds can quickly add up, £25 per week equals £1,300 a year. These can be a great help to building your emergency fund without making a conscious effort.
How much should I save?
A commonly followed rule is that you should save 3 – 6-month salary in an instant-access savings account. Although it’s important to work out how much you’ll need with a more granular approach, based on your monthly outgoings.
Don’t overdo it. There is such a thing as having an emergency fund that’s too large, and overfunding can be a detriment rather than a benefit. Having a significant amount of cash lying in a savings account will only be earning a small percentage in interest annually which is unlikely to outpace inflation, so you’ll be losing money.
Income protection is an effective way of protecting against financial shock. There are multiple options you can choose from for both premium and cover which allows for either fixed or variable rates, on a short or long-term basis. Either way, most insurance policies provide you a regular income for the period of ill health or redundancy. You can mitigate risk further by having an emergency fund with your own savings to fall back on.
It’s up to you to choose what level of protection you would like, but having a safety net in place could provide you with a lifeline and the peace of mind you’ll be financially secure in the event you’re unable to work.