Income protection

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Just because you can’t work doesn’t mean you can’t earn

As discussed in the previous article on insuring your most valuable asset, there is a determinable and serious value to be placed on your present-day ability to earn a salary and that this is worth something today. So much so that if you have anybody who depends on you as part of their financial plan, then you should take the time to consider whether you should have life insurance in place. But what about income protection?

What if you’re not dead, but can’t work?

Not all loss of income will arise as a result of death. You’re far more likely to be temporarily out of a salary due to chronic illness or the recovery from a medical procedure. Being the innovative bunch they are, life insurance companies offer a range of insurance products that can protect you from such a loss of income, both due to a temporary inability to work, as well as due to a potentially permanent condition.

Life insurance was critical when others relied on you for financial support of some kind. Disability insurance or ‘income protection’ is necessary even when it’s just you. If you could not work for an extended period, it would only be a matter of time before you ran out of sick leave and your work stopped paying your salary. If you had an emergency fund, you’d have a healthy buffer in place for up to several months, but if your emergency fund runs out… What then?

Now, not only would you not be able to support others, you’ll be unable to support yourself and may even end up becoming a drain on someone else’s financial plan.

What are your options?

The options for insuring yourself against the loss of income vary quite a bit, given that there are so many ways in which someone might lose their income. Your loss could be temporary or permanent and you may require a lumpsum or a regular annuity to replace what you have lost.

Lumpsum = single large payment

Annuity = smaller, regular payments, much like a salary.

Likewise, what would qualify you to benefit under an income protection policy might differ from insurer to insurer. Some insurance covers you for a loss of income from general employment, whereas more specific cover would protect you in instances where you could no longer perform your specific profession.

Typical income protection products will offer lumpsum amounts or annuity amounts, for both temporary and permanent disability, including various permutations of each in terms of how a “disability” is defined.

A more formal definition might look something like this: The insured can claim if they become disabled through bodily injury or illness, to the extent that he/ she is continuously unable to fulfill a substantial and material part of the duties of the regular occupation he/she engaged in immediately before the disability, resulting in a loss of some or all of their income.

What you’re worth

In instances where the insurance company pays you a regular amount in the form of an annuity, the industry will refer to this as the “replacement ratio”. This ratio was traditionally set at 75% of pre-disability levels, meaning that you would get 75% of what you used to get, should you start claiming from your income protection policy. This replacement ratio can go up to 100%.

Income protection policies typically require a period of time to elapse before you start receiving any benefits. This is known as a ‘waiting period’. You can set your own waiting period when you take out the policy with anything between 3 and 6 months being normal.

Yes, insurance companies are sneaky

The longer the waiting period, the cheaper the monthly premium. If a life insurance company only has to start paying you out after 6 months of say, post-operative care, they will be far happier, as most temporary disability claims might have resolved themselves prior to 6 months elapsing.

If you’re adamant that you need cover after the shortest possible period of waiting, then expect to pay more.

Remember of course the value in having an emergency fund. If yours is big enough, you can speak to your financial adviser about pushing out the waiting period to a longer time frame to save some money on your premiums, since you’ve already insured yourself against a temporary loss of income for a few months

You’ll probably also need at least some cash available in your emergency fund to keep things running, while you wait for the waiting period to elapse – all the more reason to make sure that you have considered your monthly expenses and have a solid idea of much you need in your emergency fund.

It’s all a part of the journey

Looking at some personal finance basics…..

  1. Track your money to figure out how much the difference is at the end of the month.
  2. Build your Emergency Fund.
  3. Sort out your insurances.
  4. Make a plan to pay off debt.

Got income protection from your employer?

If you work for an employer you may already benefit from some kind of income protection. This may or may not be sufficient for your needs. It is likely that if you have cover of this kind that your replacement ratio is only at 75% or 80%. This may mean that you’d need to adjust your lifestyle and priorities. People are often forced to cut back on retirement savings or skip on regular medical care for themselves and their dependents – not something you want to be forced to do.

If you think you have a form of income protection from your employer, speak to your HR department and get details. And if you are unsure as to what your benefits are, your HR department should be able to assist. For more technical questions, a representative from the insurance company who offers the cover to your employer will help you out.

If you think that you need more cover, speak to a financial adviser and share your existing cover details with them.

If you are self-employed the need for income protection becomes even more obvious. You don’t enjoy sick leave and there is zero chance of some existing cover being in place.

Bringing in the muscle

We get that income protection sounds confusing. It’s one of the more complicated financial products, as there are so many different ways to insure your risk. This is why we would urge you to engage with a financial adviser who can assist you with finding a solution that works for you.

While we won’t get into a technical discussion on why exactly it is that you need a financial adviser, the risks of ‘winging it’ are apparent when you consider whether to take a lump sum or an annuity when claiming.

Cash in the hand sounds great and lots of zeros makes one feel warm and fuzzy, but you would now bear the risk of making that amount work for you and provide you with an income, possibly for the rest of your life.

If you choose to take an annuity, the life insurance company bears that risk. They have to make sure that they keep paying you an amount they said they would, and if you’d negotiated an inflationary increase in the annuity, that they can likewise keep up with inflation on the payments.

How to choose a financial adviser and when exactly you should choose to seek their advice will be discussed in another post. Involving one will likely not cost you anything. Get comparative quotes and make sure that you understand all the workings of the policy as its being explained to you.

Like everything else, your needs will change over time

Your Income protection needs could change often as you change jobs, from one in which no ‘free’ cover was provided to one in which a replacement ratio of 100% was offered. The industry offers products that are dynamic enough such that they can be exited and entered into easily enough to cater for your specific needs.

As with life insurance, as you approach retirement, the financial hardship you might face from a lack of income would be less and less, as should something happen to you that would see you lose your ability to earn an income for a temporary or even a permanent duration, your accumulated savings should be able to fill that need.

In conclusion

The choice to protect your income stream is yours to make. If income protection cover is something you might need, then paying for it should be something that you don’t think twice about. It’s a necessary expense and is associated with earning an income – it’s all part of the deal that you signed up for, when you agreed to tackle personal finance DIY.

A subsequent note:

We get that paying for any grudge purchase is tough, so rather than hear us repeatedly try and convince you about the benefits of life cover, income protection  and critical illness cover – take it from arguably the most well-positioned guy in SA to talk about these things. Peter Bond is the Chief Medical Officer for Old Mutual. This means he’s pretty much seen it all, when it comes to the unimaginable and the unfortunate.

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