By LESLEY GREGORY
Human capital is our personal ability to increase our wealth. Just as you try to protect your financial capital, it’s also important to protect your human capital.
Each year about one million people in the UK find themselves unable to work due to serious illness or injury, yet only a minority of people have income protection insurance.
Income protection cover supports you and your family if you can’t work because of illness or injury. Its tax-free payouts will help you continue meeting expenses – including big ones like your mortgage – at a difficult time, leaving you to concentrate on getting better.
It could also allow you to continue to save and invest, avoiding a big break that would have significant impact over a lifetime.
An expensive gap
Consider this back-of-the-envelope calculation: Let’s say you save or invest £200 a month, for a conservative average return of 5%, over 30 years. You should end up with around £167,000, including the £95,000 you earn in interest.
Now, let’s say you fall ill and are off work for six months, fairly early on in that period (again, this is a rough calculation, and the impact will vary depending on when the gap occurs). You don’t have income protection insurance and you have to cut back to a bare-bones budget that doesn’t allow for savings. Under this scenario, that six-month gap could cost you more than £5000, most of it in the interest you would have earned but didn’t. That income protection insurance premium might not look so expensive now.
The longer the savings break (and the higher the savings you had planned), the worse the impact. Illness or injury that stops you working may even mean you eat into the savings you already had. It could mean you’re forced to sell investments even if that means crystallising a loss when the market is down. In the worst-case scenario, it could mean you lose what may be your largest financial asset, your home.
What to look for
Having decided that you need this sort of protection, you should look for a product that’s going to give you the cover you require while also being good value for money (which doesn’t necessarily mean the cheapest policy).
Income protection policies come with different options, perhaps the biggest difference being between those that come with a cap on payments, commonly two years, and those that will pay out until retirement age if necessary should you suffer a life-long incapacitation.
Those capped, short-term policies are definitely cheaper but in the event of a serious, long-term illness or injury you’ll be left to your own, vastly diminished, resources after two years. A slightly higher premium might be well worth paying to protect a lifetime of human capital – something that sick leave and/or government benefits will not be able to do.
You can work on the right balance of price and cover by playing with other elements of the policy, such as when it should kick in. Your sick leave provisions and personal circumstances might mean you can afford to have a bigger waiting period at the front — having the insurance kick in after three months, say, in return for a lower premium now.
This is an area where it may well be worth talking to your financial planner or an insurance broker, to make sure you get the right policy for your circumstances.
Self-employed? Yes, you can get income protection insurance – and you probably should, with no sick leave available to you. Unfortunately, very few self-employed people take out income protection cover. That’s probably because they are being careful with the pennies, as they should. But in this case it may be worth thinking about the pounds.
Understand the differences
It’s important to understand that, generally, income protection does not cover the loss of your job through an event like redundancy.
It’s different from critical illness insurance, which pays out a lump sum if you fall seriously ill. Nor is it the same as total and permanent disability, or TPD, insurance, which sets high hurdles for you to be defined as totally and permanently disabled.
It’s also very different from the widely mis-sold payment protection insurance, or PPI, which protects your lender if you’re income is interrupted and you can’t pay your debts. Those payouts go to your lender, not you.
A note on COVID
You may be wondering how income protection insurance interacts with the extraordinary circumstances of the current pandemic. In the unfortunate event that you fall ill, being able to claim will depend on whether a “pandemic” is excluded in your policy. You’ll need to check the terms and conditions of your individual policy.
As for lockdowns and shutdowns, where you are well but off work, income protection insurance generally does not cover workplace closures or quarantine where you are not sick or injured. Again, check your policy, and get advice.
LESLEY GREGORY is an experienced personal finance and consumer journalist, based in Sydney, Australia. She regular writes for TEBI money and personal finance issues that aren’t directly related to investing.
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