Income protection is a valuable insurance that is often overlooked or dismissed by clients. This insurance pays out a monthly benefit based on your earnings (typically up to 60% of your gross income) if you are unable to work through illness or injury for a prolonged period of time. This type of cover is different from other forms of life cover, or critical illness cover, in that the purpose of this insurance is to replace your income, rather than paying a lump sum on death or diagnosis of certain critical illnesses.
There are a number of common misconceptions when it comes to income protection, resulting in it being one of the least common types of cover being put in place, but also the most common insurance that we are likely to need throughout our lifetime.
In life we tend to insure a number of physical possessions such as our cars, phones and houses, but it is rare that we think about covering our income, were we unable to work through illness or injury, which in most cases will be one of our biggest assets over our lifetime. When looking at these figures in more depth, research provided by www.finder.com indicates that 40% of households wouldn’t be able to survive one month if their income were to stop, which demonstrates the value of this cover and why it shouldn’t be overlooked.
What is Income Protection?
Income protection is an insurance that in the event of you being unable to work through illness or injury for a prolonged period of time, will pay a regular tax-free amount of up to 60% of your gross income. This insurance is useful as it is used as a replacement of income, if you are unable to work (as mentioned above) so that you continue to receive an income, which can then be used to pay bills or your mortgage. This cover will therefore, hopefully, allow you to maintain your financial situation without causing you to become financially vulnerable.
Why is Income Protection important?
Many believe that if they are unable to work through illness or injury for a prolonged period of time, that the state will provide for them. Whilst this is true to a certain extent with Statutory Sick Pay being in place, this only provides an amount of £96.35 per week for up to 28 weeks and is only applicable to the employed, with the self-employed not eligible to receive anything. Although this is a useful benefit, most UK adults have outgoings far in excess of £415 per month meaning this would not be sufficient to continue repayments of a mortgage (for example) with the remainder needing to be covered by savings, and if unable to work for a period of over 28 weeks, once the payments have stopped, you would need to fully fund yourself from any cash savings or investments you may have.
Why should all working adults consider having Income Protection?
As mentioned above, most UK adults will have outgoings in excess of what they would likely receive as Statutory Sick Pay, meaning that any surplus of income over expenditure, would need to be funded from cash reserves. The average UK earnings of £31,461 per annum (based on the Office of National Statistics figures for the year ending 5th April 2020) provides a monthly net amount of £2,086 (not taking into account pension contributions). Therefore, anyone unable to work would suffer a reduction of c. £1,700 per month initially, with this then being a reduction of over £2,000 after the 28-week period.
As an example, if you had outgoings of £1,500 per month, initially you would need to self-fund around £1,100 of that whilst receiving SSP, with you needing to fully fund this after the 28 weeks have lapsed. This means from your savings or investments, this would cost around £16,500 in year one, with this only increasing if you were unable to work for longer than 12 months. If this were to happen, at what point would you run out of money and become financially vulnerable?
Common misconceptions around Income Protection:
“I can’t afford it” – This is a common objection and is normally unjustified. The Exeter Friendly Society has previously given an example of a 35-year-old non-smoker taking out cover until age 65, with a two-year claim period and 26-week waiting period which could pay a benefit of £1,750 per month for a monthly premium of less than £10 per month.
The real question shouldn’t be “can I afford it?”, but more so “can I afford to not have it?”.
“I’ll rely on state benefits” – Many people believe that if they are unable to work due to illness or injury that the State will then look after them (as mentioned above). Although the State does provide Statutory Sick Pay (SSP), this equates to an amount of £96.35 per week (£417.52 per month) and only lasts for a period of 28 weeks.
The average length of a claim from Exeter Friendly Society is 60 weeks, more than double the length of time of Statutory Sick Pay, meaning you would need to self-fund the entirety of your expenditure for 32 weeks or more.
“I’m relatively young, I’ll recover” – It is not uncommon to believe that “it won’t happen to me” or “I’m young so I will be able to recover”. Whilst the latter statement may be true and younger people may recover from the illness or injury that sees them not able to work, this does not take account the income they will require during the time they are off or the length of time that they are unable to work.
Exeter Friendly Society undertook some research which showed that during 2019, the average age of a claimant was 34 years old and as mentioned above, the average length of a claim was around 60 weeks.
“I already have life cover” – Whilst it is encouraging that so many have cover in place for their death, most do not cover themselves during their lifetime. Although having life cover will pay a lump sum in the event of their death (often to repay a debt such as a mortgage), many clients don’t insure their annual income which over a period of their working lifetimes, can equate to being their largest asset. The average UK house price is currently £234,742 which means, based on the average earnings of £31,461 in the UK, if you are unable to work for a period of 10 years, your loss of income could actually equate to a larger sum than the value of your property (c. £314,610 based on the UK average earnings over a 10-year period without any increases or inflationary increases).
“The policies never pay out” – A recent study has shown that 93% of claims every year for the past 10 years have been paid out, demonstrating the promising likelihood that if a claim is made, then the cover will pay out.
“I’ll probably get an illness that isn’t covered” – This is another common misconception and is where people often confuse critical illness cover with income protection. Critical illness cover pays out a lump sum on diagnosis of certain critical illnesses predefined by the provider and therefore you could develop an illness that is not covered. With income protection, the benefit is payable if you are unable to work through illness or injury for whatever reason for a prolonged period of time (as long as this is assessed by a doctor). Income protection therefore does not relate to specific illnesses but instead your ability to carry out your own occupation or specified daily tasks.
In conclusion, what we need to ask ourselves is how long we would be able to cope financially, without cover in place and what the real value of having this cover in place provides, not only financially, but, for peace of mind.
As a long-standing and trusted wealth management firm based in Northampton, not only can we provide clients with an ongoing financial planning service in respect of investments, pensions and protection, but we can ultimately help you to achieve your personal life goals. If you would like to discuss your financial planning, or any other area of financial advice in more detail, please give us a call on 01604 621421.
Cave & Sons Ltd is authorised and regulated by the Financial Conduct Authority (FCA), Financial Services Register number 143715. Tax and Estate Planning services are not regulated by the FCA.
This communication is for general information only and is not intended to be individual product/investment advice, tax or legal advice. The views expressed in this article are those of Cave & Sons and should not be considered as advice or a recommendation to buy, sell or hold a particular investment or product. You are recommended to seek professional regulated advice before taking any action.
For more information visit www.caves.co.uk or call 01604 621421.