Also known as salary continuance insurance, provides you with up to 75% of your income in the event that you are unable to work due to illness or injury.

You can also choose to protect a smaller percentage of your income at a reduced rate, or insure a higher percentage. For example, for the purposes of super contributions, you may be able to insure up to 80% of your income.

Deciding if you need income protection insurance

Income protection insurance can be important if you:

• Are self-employed or a small business owner, as you may not have sick or annual leave
• Have family members or dependents that rely on the income you earn
• Have debt, such as a mortgage, you'll need to make payments on even if you're unable to work.

To work out how much income protection you need, prepare a budget. This will help you see your monthly expenses and the income you'll need to replace. You may want to factor in making payments to your super as well.

Also consider:

• If you have total or permanent disability or trauma insurance, that can help replace lost income
• If you have private health insurance that could help pay for any medical expenses
• What help or support from family or friends may be available.

Check if you already have income protection insurance through super. Most super funds offer default income protection insurance that's cheaper than buying it directly.

When do I get paid?

Most policies have an agreed waiting period after illness or injury before benefits become payable. Waiting periods vary, with some as short as 14 days but it’s more common that they are 30 or 90 days, and they can even last up to two years.

A longer waiting period tends to reduce the premiums you pay, so a policy with a 90-day waiting period will usually be cheaper than one with a 30-day waiting period.

If you have some accumulated savings or sick leave you can use to support yourself, choosing a longer waiting period can save you some serious dollars.

How long does the benefit last?

Benefits will typically continue to be paid until the end of your period of illness or injury or until the benefit period of the policy ends – whichever comes first.

Benefit periods of policies can be for agreed fixed terms (commonly for two or five years) or to an agreed milestone (such as your 65th birthday).

A policy with a longer benefit period will typically be more expensive than a policy with a shorter benefit period.

What’s the cost?

Premiums for income protection insurance vary widely as there are plenty of insurers and combinations of cover available, and different ways you can pay.

Lifestyle factors such as your physical health and occupation will also affect the premium price.

Research will help you understand what is available and at what price, but a good rule of thumb is to expect the premiums to be anywhere from just under 1% up to 2% of your annual income.

Extras

Despite the concept of income protection being a relatively simple one, the range of benefits and options available with policies can be confusing. Common ones are outlined below.

• Indemnity benefit and guaranteed benefit

  • An indemnity benefit is paid as a percentage of your pre-disability earnings, usually the average of 12 months’ income prior to your claim, while a guaranteed benefit is paid as a percentage of your income level when you start the insurance policy – regardless of what your income is when you make a claim.

  • If your income is stable over time, an indemnity benefit should be just fine. If, however, your income is volatile (for example, if you own your own business or work on commissions) or is likely to decrease over time it may be worthwhile having a benefit based on a guaranteed income level.

  • Guaranteed benefits generally come with higher premiums.

• Exclusions

  • Some policies will specifically exclude certain types of claims, such as mental health claims. This might be a feature of the policy itself or specific to you based on the medical evidence you provide.

• Claim indexation

  • If you are receiving a long-term benefit (longer than 12 months), claim indexation ensures that payments increase with inflation over time, protecting the real value of your benefit.

• Ancillary benefits

  • A variety of additional benefits, sometimes including additional trauma or other injury-specific benefits.

• Stepped or level premiums

  • Stepped premiums start out low and increase with each year that passes. Level premiums start out more expensive than stepped premiums but do not increase with age. If you were looking to hold insurance cover for a long period of time, level premiums may be the cheaper option, but you should do your research and run the numbers.

How does it work?

Let’s use an example. Nathan is a 40-year-old accountant who earns a yearly salary of $100,000. He has an income protection policy that insures 75% of his salary with a 90-day waiting period and a benefit period to age 65.

Nathan is seriously injured in a motor vehicle accident. His injuries mean he is unable to work for at least the next six months. He will not receive any benefit from his income protection policy for the first 90 days (his waiting period), but from that point he will be eligible for a monthly benefit of $6,250 ($100,000 x 75% / 12).

If Nathan’s injuries prevent him from ever re-entering the workforce his monthly benefit will continue to be paid to age 65 (his benefit period).

Using super

When income protection cover is offered via super, the policy needs to comply with the relatively strict confines of super law. The benefits paid under such a policy must align with the ‘temporary incapacity’ condition of release.

Unfortunately this means the benefit that can be offered is a bare-bones type of benefit. The policy will typically be an indemnity-type policy, won’t be able to pay a benefit if you cease work for any reason other than illness or injury, and won’t provide an injury-specific benefit.

The upside, however, is that you can use your super benefits to pay the premiums (but over time will impact what you save for your retirement).

Some life insurance companies will offer you a bare-bones policy inside super and a more comprehensive top-up benefit outside super. This type of structure, typically known as splitting or linking of benefits, can give the best of super and non-super solutions.

Not all policies are created equal. A slight difference in definition can make a very large difference in benefit. Compare the benefits provided, not just the premiums charged.

Tax issues

Just like the income you are protecting, the benefits you receive from an income protection policy will be assessable and subject to tax at marginal tax rates – because you’re still earning a salary, it’s just coming from the insurance provider, not an employer.

If held in super, premiums are paid for using your super and are generally tax deductible for the trustees of the super fund. If outside, you can claim the cost of premiums you pay for insurance against the loss of your income.