Whether you are a small business owner, a contractor or an employee, there are good reasons why income protection should be a priority.
Your income is your biggest asset
Forget about the house and the car. Your biggest asset will be the income you earn over your working life.
You may be surprised at just how valuable this is. If you are earning the median income of around $80,000 and this is indexed by inflation of 3%, then over 35 years you will earn more than $5 million!
Now imagine that due to a long-term injury or illness you are unable to work again. Your income is now reduced to a disability pension from the government of around $23,000 a year. You just lost $3.5 million in future income!
Losing your income has serious consequences
Think about the effect that losing your income would have on your ability to pay bills and the mortgage.
If you are single what effect would this have on your lifestyle? You would most probably have to move back in with your parents, lose your independence and lose your ability to save and plan for the future.
If you have a family how would this affect their living standard? You may have to sell the family home to find a cheaper residence or maybe rent. Maybe your partner would have to work full time. Overseas holidays and non-essential purchases would be severely curtailed. Plans to send your children to a private school would be out the window.
Worse of all, your dream of investing to get ahead and having a comfortable retirement would be shattered.
How can income protection insurance help? Income protection can provide up to 75% of your income to age 65 while you are unable to work. Why only 75% you ask? This is to ensure that there is still an incentive to return to work.
However don’t be fooled, as all income protection policies are not created equal. Policies with a 2 year benefit period are offered by many super funds and other providers. These policies might help you weather a short-term injury or illness, but they will not provide long term financial security should you face something more serious.
Income Protection premiums can be claimed as a Tax Deduction
With so few work-related deductions to claim nowadays, income protection offers the ability to save on tax.
Because your income protection premium is considered an expense incurred to protect against the loss of income it is treated as fully tax deductible by the ATO. This is not the case for other insurance covers e.g. Life, TPD and Trauma insurance.
Your insurance company will provide a tax statement after the end of the financial year stating the premium which can be claimed.
The higher your income generally the higher the tax saving. On the highest marginal tax rate of 37% a premium of $1000 could end up costing only $630 after the tax deduction.
You can claim for premiums paid within a financial year. Therefore if you pay your annual premium in June this allows you to bring forward your tax deduction into the current financial year.
Workers Compensation and sick leave are simply not enough
If you are covered by a workers compensation policy you may think you don’t need income protection. However the two covers are very different.
Income protection policies provide 24 hour and worldwide cover.
Workers compensation only covers accidents arising during work hours. This means car accidents outside of work, accidents at home and injuries while playing sports are not covered.
Illnesses account for the majority of income protection claims however most of these would not be covered by workers compensation.
If you have accumulated large amounts of sick leave you may also feel that you don’t need income protection. A few months sick leave may be enough to cover a break from work due a broken limb or a short term illness. However this will be insufficient for an ongoing illness such as cancer or multiple sclerosis or a major back injury.
On the upside, if you have a large amount of sick leave you can save up to 40% on your income protection premiums by choosing a longer waiting period.
Of course if you are a contractor or small business owner you are unlikely to have the luxury of workers compensation or sick leave.
Income Protection is even more important for the self-employed
Many business owners tell me that they don’t have income protection because they don’t think they are eligible.
But that is not the case. Income protection policies can be taken out whether you are employed or self-employed. Arguably income protection is even more important when your business may collapse if you cannot work due to sickness or accident.
However for the self-employed the calculation of income is slightly more complex. If you are a sole trader or contractor the amount you can cover is your net income after expenses (before tax) calculated by your accountant with some items like depreciation added back.
If you work for a company that you own your income will be the salary you draw plus your share of the profit or loss of the company. Where a husband and wife business employs income splitting insurers will usually be prepared to look at who is really generating the income.
Insurers do however want to see stability and continuity of income. If there have been fluctuations in your income over the last 2 to 3 years they may average your income. If there have been breaks in work you may need to explain the reason for these.
For the self-employed Agreed Value or Guaranteed income protection should be a priority, providing the appropriate financial evidence can be produced for the last 2 to 3 years. Agreed value cover means you will have certainty as to how much the insurer will pay on a claim in the future, even if your income fluctuates.
However indemnity cover, where income evidence is provided at the time of claim, will usually be available. Then it becomes important which indemnity definition is being used by your insurer i.e. will you be covered up to 75% your highest income over the last one, two or three years.
While income protection policies have numerous features and benefits, it is well worth investing the time researching your options to end up with a quality policy suited to your needs.