Income protection insurance explained

The UK is facing a huge protection gap. The vast majority of people rely on their salary each month, yet only a small minority have any protection against losing it. 

That’s where income protection comes in. 

What is income protection insurance?

Simply put, income protection insurance is a level of cover to help with living costs if you lose your income because of being unable to work due to illness or injury. It’s usually paid as monthly income, in addition to statutory sick pay, and depending on the policy, it either stops paying after a fixed period, when you return to work, or at retirement age.

What income protection insurance doesn’t usually cover is redundancy situations. If you lose your job but are still fine to work, you need a different type of cover (unemployment or redundancy insurance). Income protection is specifically about being medically unable to work. 

It also helps to separate this from other protections. Executive income protection or key person protection is geared toward protecting companies if someone important is lost. And critical illness cover normally pays a one-off lump sum for specific conditions like cancer, a heart attack, or a stroke. 

From a tax perspective, if you’ve always paid the premiums for income protection insurance yourself from taxed income, payouts are tax free (otherwise you’d be getting double taxed). In cases where your employer pays the premiums for you, the payout may not be tax free. But it’s worth checking if your employer provides this as it can provide you and your dependents with a level of comfort.

Is income protection worth it?

Income protection is usually worth it for anyone whose financial life would be significantly disrupted were they suddenly unable to work. According to the University of Bristol, that’s most adults – 56% of households would struggle to cover even one month of expenses using their savings alone. 

Most people underestimate how common long absences can be. Back problems , stress, mental health issues, and recovering from operations, can all keep people off work for months. 

“But it won’t happen to me.” 

Here’s a stat for you: The 2024 Guidewire Insurance Consumer Survey shows that customers with no claims tend to hold negative views of the industry and are less likely to bother with insurance. But after just one claim, customers who had to use their insurance report positive feelings. 

Sadly, unwelcome news is experienced by all of us through life. And sadly, only then do most people realise the value of cover. Currently, only around 14% of UK adults have income protection.

How much is income protection insurance?

Between £5 and £50 might buy you basic protection, depending on your health. If you’re looking for a comprehensive policy that pays until retirement, it could be up to a hundred pounds per month. And if you’re a higher earner, it could be a couple of hundred pounds a month. Self-employed income protection policies offer flexible coverage and might typically cost £30 to £80.

How much does income protection pay out? 

The first thing to say here is that it probably won’t cover your entire salary. Normally just 50-70% of your usual earnings. That underlines the fact it’s meant to cover your living expenses and not the luxuries you may be used to. There are three key factors in what income protection payout you’ll get:

• The length of the deferred period – this is the waiting time before payments start. If you have employer sick pay or some savings, you could have a longer deferred period, and this would reduce the cost of your policy.
• How long it pays for – some plans cover you for a year or two, but others can keep paying for decades if needed. The longer the selected payout period, the more expensive the policy.
• If its inflation linked or not – linking long-term payments to the Retail Price Index (RPI) or Consumer Price Index (CPI)can be a good idea to protect your standard of living but the premiums will cost more than for a level payout

Do I need an emergency fund if I have income protection?

Yes, absolutely.

It’s important to remember that income protection only jumps into action in specific circumstances. For example, it won’t help if you’re made redundant. It also won’t help if you struggle with an unexpected bill, the boiler goes, or a family member needs supporting and the responsibility falls to you. If you save up an emergency fund, on the other hand, you can use that money for whatever reason you need to, whenever you need it. Not to mention, an emergency fund to fall back on means you won’t resort to cancelling premiums for short-term cash.

In practice, the two work well together. The emergency fund helps you for short-term, one-off shocks, and income protection insurance is there for you when a more lasting problem hits.

Do I really need income protection insurance?

It comes down to how financially resilient you are without your salary.

If you could comfortably live off your savings for several years, perhaps it’s less vital. But bear in mind that savings alone are not always ideal to fall back on. Wealth tied up in property, businesses, or investments can’t always be accessed at the drop of a hat. If forced to sell illiquid assets at short notice to pay for bills, for example, you could face hefty penalties or losses. 

If you were incapacitated, it would be up to your loved ones to try to unlock your wealth. The whole point of insurance is to remove that burden, take anxieties away, and allow you to focus on recovery. 

A common theme among wealthy individuals is having patchy cover. You might have life insurance from earlier in your career, but no income protection. Or perhaps your business is well protected, but your family relies on assets that aren’t liquid. 

Even if your workplace offers income protection it might only cover you for a period – say six months or a year. After that you will have to rely on statutory sick pay. If you have private protection that kicks in after your employer’s scheme stops supporting you this can increase your financial resilience and peace of mind. And the monthly premiums will be a lot lower.

A financial adviser at Charles Stanley recently said that nearly all conversations with new clients start with income protection, so get in touch now to have your questions answered. You can book a free 15-minute consultation with a Charles Stanley financial coach here.