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The strength of any building is determined by the soundness of the foundations. Without solid ground, any shock to the structure invariably leads to damage being incurred.
The same principle applies to financial planning. Often one rushes to take on financial commitments and make habitual pension or other savings without considering the security of the source of funds for these endeavours – your income.
Put simply, the cornerstone of any sound financial plan is protection.
When considering the need to protect your loved ones, the first provision used for most people tends to be life assurance. This is since it tends to be the lowest cost, most accessible, and indeed the most well-known form of personal and family protection. After all, we cannot cheat death!
However, it is my belief that an alternative form of protection, which replaces your income if you are unwell but survive, can be much more important.
Your ability to earn enables all your savings and retirement-planning goals as, after all, without an income you cannot contribute towards your pension, save towards your individual savings account (ISA), or indeed pay rent or meet your mortgage repayments.
If you are unwell and unable to work for a considerable period of time, you may be eligible for Statutory Sick Pay (SSP) of £96.35 per week, payable by your employer for up to 28 weeks. Indeed, your employer may offer improved sick pay benefits – for example, full pay for a predetermined number of weeks, perhaps followed by half pay for a similar period. However, this type of support is usually limited in terms of the sum paid and the duration of payment; therefore, it is important that personal responsibility is taken to protect your own income. This is best achieved via a personal income protection plan.
Income protection is essentially a personal permanent health insurance contract between the individual and one of many life assurers who offer such cover in the UK.
Like any form of protection, these plans are medically underwritten, so disclosure of medical history is required. Once underwritten and premiums are being paid, such a contract will run until your chosen plan end date, which would usually be retirement age. This gives continuity of cover until such time that pension benefits, whether personal or state benefits, are available.
So let us look at how these plans actually work.
You can choose to insure a proportion of your gross earnings, with some insurers taking into account salary, bonus and dividend income. After a predetermined deferment period, if you are unable to carry out the principal duties of your own occupation (due to illness, incapacity or accident), then a claim would be reviewed by the insurer and, if the criteria are met, benefits should be paid.
A deferment period is the number of weeks you can cope without ongoing income being provided, perhaps because you have sick pay support from your employer, or savings to fall back on. It is important to dovetail this period with any ongoing income provided to you. For example, a deferment period could be set at 0, 4, 13, 26 or 52 weeks. The longer the deferment period, the less the monthly cost to you, or premium, will be.
For example, an individual with qualifying earnings of £100,000 would typically be able to insure up to 60% of this sum and that benefit may kick-in after 26 weeks’ illness, with the cover running to age 65.
It is important to note that benefits paid from an income protection plan are paid without the deduction of income tax or national insurance contributions. Hence a cap of around 60% of gross earnings being applied. After all, no insurer wants their clients to be financially better off in the event of a claim than they were when they were working!
An important point to note is that an income protection policy is put in place on a contractual basis until a specified end date, which is usually linked to your retirement age. Therefore, in a worst-case scenario, one long-term claim could be made (or perhaps a series of claims, even for the same condition), subject to qualifying criteria and of course the specific terms and conditions of each arrangement. Flexibility could be added by including indexation of benefits, so they can increase by a fixed percentage, or perhaps the rate of inflation but, of course, the premium will also increase by an equivalent sum.
The Association of British Insurers’ (ABI) protection report of 2020 shows that during that year 86.5% of all income protection claims were paid, with an average annual claim being £22,170. The overwhelming reason for a claim not being accepted was shown to be non-disclosure of an existing medical condition – it is vital that medical history is disclosed fully and accurately at application stage.
The most common conditions leading to a successful claim are musculoskeletal conditions, such as back injury and limb disorders, cancer, and of course adverse mental health.
Given the Covid-19 pandemic and the expected impact of this traumatic period, it is anticipated that remote working, isolation, and anxiety within the population will lead to a higher incidence in income protection claims in the coming months and years. While understandably we have all been preoccupied with Covid-19, the impact of two years of disruption to our lifestyles should not be underestimated.
The need to protect your income has never been greater, with new pressures being felt by many, whether that be changing working habits, increased cost of living or of course our health and wellbeing perhaps being more at the forefront of our thinking.
I believe for many of us, the likelihood of sudden or early death is less than the chance of a prolonged illness and our financial strategy should take this into account.