How to protect my income: a guide

All you need to know about protecting your income

Most people want the security of a steady job and a regular income. When we’re in work our finances seem stable, our lifestyle secure and our future plans achievable. Losing your job can be devastating, but this isn’t the only way in which you can suffer loss of income. Poor health plays a bigger part than many people realise. Fortunately, there are plenty of things you can do to prepare for the unexpected and minimise its effect on yourself and your family.

What are the options for protecting your income?

Some health problems put you out of work for several months, but in time you’ll recover and return to your job. Other health problems can mean you’ll never work again. Although there are several short-term and long-term solutions, this guide focuses on two types: insurance and savings.

Insurance

There are several insurance options that provide income protection for employees and the self-employed.

Income Protection Insurance

An income protection (IP) policy gives you a regular income if you become ill or injured and have to take an extended break from work.

Sometimes called Permanent Health Insurance, IP is a form of insurance which is little known and even less used. According to the Financial Conduct Authority only 6% of working people have it, even though it has existed in some form for 200 years**. The principle of workers paying into a fund that gives financial support to members of the group who become too ill or badly injured to work dates back to the friendly societies of the Industrial Revolution, when workers had no financial safety net. Today it’s provided by most insurance companies, but although it’s available to anyone who works for a living, it’s rarely offered except as protection to people taking out mortgages.** Many people rely on their employer’s sick pay schemes or statutory sick pay.

What is statutory sick pay?

Employers are obliged by law to pay their employees while they’re off sick, but how much is statutory sick pay? Currently you’d get £118.75 per week for up to 28 weeks. For most people, that falls far short of compensating them for their lost income, which makes income protection very attractive. Some employers choose to offer more generous schemes, in which case income protection can be arranged to kick in when those schemes end.

Self-employed income protection

If you’re self-employed, state mandated support is even lower. Since you don’t have an employer there is no one to give you statutory sick pay. Instead, you can claim a state benefit, Employment and Support Allowance. This is currently just £92.05 per week.

Like any insurance policy, you pay a monthly premium throughout the life of the policy and if you’re forced to stop working you make a claim, which, once approved, pays you a proportion of your normal salary until you’re fit enough to return to work or you reach the end of your pre-agreed claims period (the Benefit Term). Claims can last from as little as a few weeks or, depending on the policy, for 2 years or more. As long as you keep paying the premiums, you can claim as many times as you need to.

Accident Only Insurance

This covers you if you lose your income as a result of an accident. It doesn’t cover you for illness. It works in the same way as income protection, allowing you to claim as often as you need. It is often chosen by people with health conditions that prevent them from getting income protection.

Critical Illness Insurance

This way of guaranteeing financial security operates very differently from IP. It pays you a lump sum if you’re diagnosed with a serious illness specified in the policy and that illness stops you from working. Conditions covered include heart attack, cancer, stroke and multiple sclerosis. Policies vary in length from 5 to 40 years but you can claim only once. After the policy pays out it comes to an end. One advantage over IP is that you receive a lump sum to do with as you wish. Among its disadvantages are the limited number of conditions covered, the varying definitions of those conditions from one policy to another and the fact that it provides only one-off help.

Life Insurance

A life insurance policy pays out on the death of the person who is insured, with either a lump sum or regular payments to the people named as beneficiaries. Its purpose is to provide financial protection for loved ones and dependants when the policyholder passes away. Unlike IP and critical illness, it doesn’t help the policyholder, but they do have the peace of mind of knowing the people they leave behind will be looked after. Not only can a life insurance payout take care of immediate financial burdens like funeral costs and outstanding debts, it also provides for the living expenses of those left behind.

There are several types of life insurance of which the most common are these:

Whole life

This covers the insured’s life for as long as they live, usually with premiums that stay the same throughout. Many whole life policies also build up a cash value which makes them an asset that can be borrowed against, cashed in or used as security for a loan.

Term life

These policies have an end date which means cover lasts for only a specified time. This makes it suitable for people who want to make sure their dependants are looked after until they become financially independent, or who need to ensure a long-term financial commitment like a mortgage will be paid off if they die. Unlike whole life, there’s no cash value in a term life policy.

Joint life

Often chosen by partners and married couples these policies insure both lives so that on the death of either person, the other receives the payout. Once the policy has paid out, it comes to an end.

Disability Insurance

This is a variant of income protection. Many IP policies provide cover for a few years while some – sometimes called long-term disability insurance – will continue to pay out while the policyholder is unable to work up to retirement age.

Redundancy Insurance (Unemployment Insurance)

Income protection only insures you against loss of income through illness or injury so redundancy or unemployment insurance exist to cover you if you lose your job. Most policies will pay you a proportion of your previous wage for up to 12 months while you look for a new job.

It’s important to bear in mind that redundancy insurance doesn’t cover you for dismissal on valid grounds, such as misconduct or being unable to perform your duties adequately. Neither does it pay out if you take voluntary redundancy. You’ll only qualify for payment if you are forced into redundancy against your will.

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Other forms of self-employed and employee income protection

For all its advantages, insurance isn’t the first choice for everyone. These alternatives can work on their own or in conjunction with insurance policies.

Emergency Fund

This involves building up sufficient savings to provide a financial safety net. The main advantage is that all the money you put into your fund stays in your possession. However, you need to be disciplined and consistent about how much you put away if you’re going to save enough to cover all your expenses when you might have to go without an income for several months. It could be a long time before your fund is big enough to support you, whereas an insurance policy gives you immediate cover. The other disadvantage is that, once you’ve spent your emergency fund you have to start the process of saving all over again. In contrast, income protection policies allow you to claim as often as you need.

Investments

Investing can be an excellent way of building financial resilience. It could pay you regular dividends to add to your savings and in deeper emergencies you can always sell your investments. The big risk of investing is that the stock market can be volatile. Even with expert advice, there’s a chance the value of your investment will go down as well as up, so you can’t guarantee that it will be worth what you hoped at the time you need it.

Debt Management

This option is for people who already find themselves in financial difficulty, with debts they’re struggling to pay. It’s designed to reduce the burden of debt and improve financial stability, starting with an assessment of your income, expenses, assets and liabilities, followed by budgeting, debt consolidation, repayment strategies and debt management plans. It’s a complex exercise that requires advice from financial advisers and debt management companies or charities. Its effectiveness in protecting your income comes as something of a last resort, so it may be best to take action before you reach this stage.

Making the right decision

Finding insurance to protect your income is relatively straightforward. Insurers are under a legal duty to prioritise the interests of their customers so the information they provide will be accurate, even if it isn’t always jargon-free and easy to understand. If you shop around, you should be able to find the right policy for your needs.

Legal and financial advice

The investment and debt management options for protecting your income are not solutions that most people could arrange by themselves. It’s wise to seek input from independent financial and legal advisers. This will often involve fees, although in the case of debt management there are charities that specialise in helping consumers get on top of their debts.