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Income protection insurance

Income protection insurance is a safety net for high and sole-income earners whose capacity to work is compromised. It ensures that the insured will receive a steady income stream that replaces their salary—even in the face of a debilitating physical or mental condition.

Unlike a total & permanent disability (TPD) and life insurance, it pays a calculated income stream based on pre-tax salary if unforeseen events force an individual to take time off work temporarily.

However, no matter how high a premium is, policyholders will not benefit from it if they still have the capacity to work or are simply temporarily unemployed because of resignation or reasonable termination.

What does income protection insurance cover

Every income protection product is different, but the factor that links all of them is that they only pay out when the insured can prove that they do not have the capacity to work.

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As long as the insured is able to work in some way, they don’t receive benefits.

Some of the important questions a person needs to consider when getting income protection insurance are the following:

Does income protection insurance cover redundancy and termination at work?
Reasonable termination of work and redundancies are not covered in income protection insurance. It would only be covered if the policyholder had requested to include it in their coverage and paid the premium for it.

Termination due to redundancy is typically not covered in most policies and a high premium does not assure better coverage.

Does redundancy insurance cover death?
Only if the insured dies while benefits are being paid out and if the death is a result of injuries or a condition that led to claim the benefits in the first place.

Does it cover pregnancy?
Simply put, if a woman can still move around and think coherently during a pregnancy, then she is still considered capable of going to work in the eyes of the insurer.

A woman is only rendered incapable of working while she is in labour. This means that maternity leave is not covered because it was the woman’s ‘prerogative’ to take time off work to care for her newborn child, but that does not mean she has no capacity to work.

As insurers see it, having a child is never an unforeseen event. Normal pregnancy is one of the top exclusions, along with alcohol abuse and self-inflicted injuries.

What the higher premiums cover when it comes to pregnancy could be either or both of these two things:

  1. Temporary hold
    When a woman takes a break from work due to pregnancy, they will also be allowed to temporarily pause premium payments without the risk of cancellation. They may begin paying again once they return to work or simply arrange for premium payments to be made from their life insurance while they are on leave. The usual allowable period for this is only 3 months.

  2. Pregnancy complication diagnosis not related to pre-existing conditions
    If the insured pregnant woman is diagnosed with a condition or complication during the gestation period and the condition has nothing to do with any pre-existing condition, the insurer may consider paying out benefits.

Is mental illness covered?
In most cases, yes, but policyholders would still have to check their product disclosure statement (PDS) to confirm. There are many types of mental illnesses and not all of them are covered—unless it was deliberately added to the policy.

Note: Full disclosure of medical history is important!
Just like any life, health and TPD insurance, premiums for income protection cover also increase for individuals with pre-existing conditions. Some companies may even require medical examinations to confirm a person’s medical history.

A policyholder must disclose all information about their pre-existing conditions. If the insured was found to have hidden the information on purpose, they may lose the entire policy.

To summarise: Income protection insurance doesn’t pay out unless the insured is unable to perform all income-producing responsibilities. They will also need to be under a physician’s care and show that they are taking steps to get better.

Income protection insurance and taxation

Income protection insurance benefits are paid out as an income stream—it does not pay lump sum benefits. 

Redundancy insurance does not trigger a goods and services tax (GST) and premium payments are fully tax-deductible under certain conditions.

If the policy was acquired through a super fund and super contributions are used to pay for the premium, policyholders can’t claim a tax deduction. Likewise, if the policy is only a part of a larger insurance policy, they may only claim a deduction for the portion which provides income.

Taxable benefits are also assessed according to whoever paid the premiums.

The conditions for taxation are:

  • If the premium is fully paid by the insured, benefits are tax-free;
  • If the insured individual’s employer pays for the policy, benefits are taxed as income;
  • If the insured and their employer jointly pay for the premium, only the portion paid by the insured is tax-free, while the rest is taxed as income;
  • If the employer pays for the premium but the insured agrees to pay the income tax, benefits are tax-free.

Is income protection insurance necessary?

Consider the two things below to help decide if income protection is necessary:

  • Monthly wage
  • Centrelink payments eligibility

Typical income protection cover pays a fixed amount calculated from 60 to 75 per cent of the policyholder’s gross monthly wage or up to $10,000. Conditions for benefit payment would continue as long as the policy’s benefit period is in effect. This can be any stretch of time between two and five years or until age-pension age, depending on the policy.

In most cases, benefits are limited to 75 per cent of the insured’s pre-tax income, but this does not mean the insured will receive that exact amount from their policy. In most income protection policies, the insured may only receive up to the amount calculated regardless of the source. This means if they receive any form of payment elsewhere, such as from Centrelink, they could receive a lower benefit from their insurer.

For instance, a $2,000 monthly income could give the policyholder up to $1,500 from their insurer. However, their fortnightly income must not exceed $1,041.67 if they want to receive Centrelink payments. This means the insured can only receive $502.87 from their policy every two weeks or $1,005.74 a month.

In this case, by just paying a premium for insurance, they can’t maximise the benefits, which seems like a waste of money. For a low-income earner, income protection insurance may not be the right product.

Medium or high-income earners, especially the breadwinners, may benefit more from this insurance.

How to claim from an income protection insurance

Claiming benefits for income protection insurance is similar to other types of insurance claims. Policyholders simply have to contact the insurance provider through a phone call, online platform or in person, depending on the insurance company.

They don’t receive their benefits right away because there is a waiting period before the disbursement of benefits. There is also a benefit period that determines how long the policyholder will receive payouts. Both the waiting and benefit period are elected by the policyholder from the start of the policy.

The waiting period is the length of time between making a claim and actually receiving benefits. Typical waiting periods are 30 to 90 days, but it can also be longer to lower premium payments. The insurer must also pay one month in arrears so the waiting period is always the elected waiting period plus 30 days.

The benefit period is the length of time the policyholder may receive income benefits when making a claim. This can be any length of time from 12 months to five years. Some policies allow a benefit period of up to the day the insured turns 65 years old—also for a higher premium.

It’s still best to discuss insurance options with an expert who can take personal circumstances into consideration.

This information has been sourced from the Australian Taxation Office, Department of Human Services and ASIC’s Moneysmart.

Income protection insurance
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