Mortgages
11 min read
Author: Darryl Scott
Darryl Scott, Insurance Adviser
Reviewed by: Andrew Nicol
Managing Director, 20+ Years' Experience Investing In Property, Author & Host
Income protection is a type of insurance. If you lose your job or cannot work, the insurance company will pay you part of your income.
It’s a way to ensure that you still have an income, even if you can’t work or lose your job.
I’ve been involved in insurance for over 20 years. Over that time people often ask: “Do I really need income protection insurance? How much does it cost? And is it worth it?”
These are all the questions we’ll answer in this article.
Some people take out income protection cover to ensure they have an income if they get sick or injured.
Think about it this way: If you lost your job tomorrow
These are frightening thoughts for many Kiwis.
That’s why some people choose to get income protection insurance. Because that way, if you can’t work, you can still afford to live.
A lot of people get sick at some point in their life.
In New Zealand, 1 in 20 adults are diagnosed with coronary heart disease over their lifetime (Heart Foundation, 2017).
It’s estimated there are 60,000 stroke survivors in New Zealand. Many are disabled and in need of daily support (Stroke.org.nz, 2018).
When this happens, your income will most likely take a hit. That may mean you can’t pay your bills or your mortgage.
That’s where income protection insurance comes in. If you have it, you can still receive an income (even if you don’t work).
Income protection insurance will pay up to 75% of your income. This is paid in regular instalments e.g. every month.
Let’s say you earn $2,000 a week, then you lose your job or can’t work. Income protection insurance will pay you up to $1,500 a week – even though you can’t work any more.
This can last for as little as 2 years or until you turn 65.
Income protection insurance is expensive. It covers more things than some other insurance types.
For example, Trauma Insurance will pay you a large lump sum (e.g. $500,000) if you get cancer or heart disease.
But income protection insurance will cover almost everything. Usually, it only excludes
As a rule of thumb, income protection can cost around 3% of your pre-tax income.
For example, let’s say you earn $100,000 a year (before tax). Income protection insurance might cost you $3,000 a year ($58 a week).
This is a ballpark only. The cost of your income protection insurance is impacted by:
There are a lot of factors, so it’s hard to give an exact figure. So, here are a few scenarios so you can gauge where you might fall.
Steve is a 24-year-old plumber on $80k a year. He decides to insure $50k of his income.
If he can’t work any more, he’ll still get $50k a year from the insurance company.
He decides to take out a policy with an 8-week waiting period. That means once he loses his income, he needs to wait 8 weeks before the insurance company starts paying him.
His income protection insurance costs:
This means insurance will cost 3% – 4.32% of Steve’s pre-tax income.
How could Steve make his income protection insurance premiums cheaper? If he increases his wait period, the premiums would be lower, as in our next example.
John is 25. He earns $70k in his office job. He chooses to insure 75% of his wage. That’s $52.5k.
He wants to make his premiums (the cost of his income protection insurance) more affordable, so he chooses an extended wait period.
His insurance won’t start paying him until 104 weeks.
That means he would have to be out of work for 2 years before his payments start.
But John takes this policy out because he only wants to protect himself if he really can’t work ever again.
In this case, income protection insurance costs John:
This is 0.56% and 0.78% of John’s pre-tax income.
But remember, these premiums are low because John’s wait time is so long. If he were to shorten the wait time to 4 or 8 weeks, his premiums would be higher.
Linda is 45, and a partner at a law firm. She’s on a huge $400k a year. She decides to insure $262.5k.
Her income protection insurance costs:
These premiums are pretty steep, but they are still only 2.17% and 3.28% of Linda’s income.
Now let’s dive into the pros and cons of income protection insurance.
The main benefit of income protection insurance is that it replaces your income if you can’t work any more.
It’s not a one-off payment like trauma insurance. This type of insurance can continue to pay until you turn 65.
One of the investors I’ve worked with currently uses his excess income protection benefit to invest in properties.
He was a chiropractor, and couldn’t work after an illness with his wrists. Through his income protection insurance, he's getting paid $138k a year and will continue to do so until he’s 65.
Insurers have learned not to let people go back to work too early.
Let’s say you try to go back to work before you’re fully recovered. You might get sick again and need to make another claim.
That’s why insurers will work with you to find the most helpful solution. That could mean you go through rehabilitation or retraining.
When Michael had cancer a few years ago, he was off work for 8 months. But he got bored of Netflix well before he fully recovered.
He wanted to return to work, but his insurer was reluctant. Michael agreed to go through a rehabilitation programme at his gym.
It meant Michael was able to get healthy after chemotherapy. It did wonders for his physical and mental health. He went back to his job shortly after.
Let’s say John, a CEO, came off his mountain bike. He injured his head and this impacted his cognitive ability. John is able to work, but he’s not ready to run a company in a stressful position.
If he is medically unfit to be CEO, John could retrain and take another job. He could even decide to work in a coffee shop.
Let’s say he now earns $50k a year but he was insured for $100k a year. In this case, John’s insurance will top up the $50k difference until he turns 65 (if that’s what he initially signed up for).
His retraining and his top-up are covered by his policy.
I had a professional rugby league player come to me looking for insurance.
He knew there was a high chance he could get injured and lose his income.
Unfortunately for him, the insurance company knew this too, so I had to say I couldn’t get him income protection insurance.
The risk was too high. Few insurance companies would offer to protect his income because, as a professional sportsman, it was highly likely he would get injured.
Your premiums may be higher if you have a pre-existing medical condition or a high-stress job. This is because you have a higher chance of needing to make a claim.
All this means the cost of premiums will vary widely between people.
There are 3 different types of income protection insurance. I call them flavours.
Indemnity insurance is a great fit for employed salary earners.
Lisa makes $100k a year and can insure herself for 75% of that. It means she could get $6,250 a month if she can’t work.
This can be paid out for 2 years, 5 years, or up until she turns 65.
Unlike an agreed-value product (such as mortgage income protection), Lisa will have to prove her income at claim time.
Generally, the insurer will do this by looking at her income over the last 3 years. They’ll then look for the 12 months where she earned the most income.
Salaried incomes are pretty stable, so they are easy to prove. That’s why indemnity insurance is often a good option if you earn a salary.
But if you’re self-employed, which is more prone to income dips, you might consider the next option.
Agreed value is a great fit for people who have less stable incomes. Think, self-employed or seasonal workers.
With agreed value, the income you insure is set at the time you take out the insurance.
Let’s say, Hannah and Mike own a hotel. When everything is going great, they make $10k a month, but sometimes that can dip down to 2k a month.
If they get an agreed value policy at $6k a month, it doesn’t matter what happens down the road. That’s the amount they’re insured for.
The downside is that you can only insure 62.5% of your income. That’s lower than other types of income protection insurance.
The monthly payments you get aren’t taxed, but you can’t claim your tax back on the premiums you pay either.
The last type of income protection cover is Loss of Earning.
This is a great fit for people who earn a big salary. That’s because it’s a hybrid of agreed-value and indemnity insurance.
It tends to work best when there is an ACC claim involved.
Let’s say, Sandra earns $500k. A very high income. She insures her income for 75% (indemnity). This is $375k.
In this case, she’ll be paid out $31,250 a month until she’s 65 if she needs to claim.
But now let’s say Sandra hurt herself in a skiing accident. She’ll be grateful she went with Loss of Earnings.
Why? ACC will pay Sandra some of her income. But the payout caps out at around $135k a year. Most people aren’t aware of this.
Usually, ACC will pay out 80% of your income, but that cap can be detrimental for high income earners.
Sure, ACC will pay Sandra $135k a year, but then Sandra is still out of pocket by $365k.
This is where Loss of Earnings picks up the slack. The insurance company and ACC will still pay her.
Income protection insurance is complex. So, what you need will be different from what the next person reading this article needs.
I have had clients that are type 2 diabetic. In a case like this I have to find a sympathetic insurer for a type 2 diabetic.
You can decide that income protection insurance is right for you, but then you still need to find the right insurance company and set it up properly.
That’s why many Kiwis decide to speak to an insurance adviser. We don’t charge anything. Opes only gets paid commission revenue if we can help find the right insurance policy for you.
If you want to talk about income protection insurance, you can always email me directly – [email protected].
Darryl Scott, Insurance Adviser
Darryl Scott is an Insurance Adviser at Opes Insurance in Auckland with over 30 years of Industry Experience. Darryl provides personal risk advice and claims assistance for individuals, families or businesses that require a functioning plan to provide funds in the event of an untimely death or major illness or injury.
