Income protection insurance: what is it, and how does it work?

Income protection insurance acts as a financial safety net that covers a portion of your income if you cannot work for an extended period due to an injury or illness. An income protection insurance plan is designed to replace a portion of what you typically earn so you can pay your regular bills, rent or mortgage expenses.

According to the guidelines released by the Australian Prudential Regulatory Authority (APRA), an income protection insurance plan can pay you a maximum of 90 per cent of your earnings at the time of claim for the first six months. If you cannot return to work within this period, your payout will reduce to 70 per cent of your income from the seventh month onwards. 

The length of time for which you can continue receiving the payout depends on your policy. Most policies offer a protection period of up to five years or pay you until you attain a specific age, such as 65.

To determine your income risk for a claim, the insurance company will consider your annual earnings at the time of the claim, calculated over the previous 12 months before the claim. If you’re someone who doesn't earn a stable income, the insurer may calculate your income based on your average annual earnings over a longer period, as considered appropriate for your occupation.

How much you pay for income protection insurance depends on what you want to cover and for how long. Apart from how much you earn and the nature of your occupation, your premium also depends on the benefit period you choose. The longer the benefit period, the higher the premium you pay. 

Another factor that could impact your premium is the waiting period before your payments start. This could range from two weeks to two years, and you should be unable to work as a result of your condition at the end of this period to be able to make a claim. A shorter waiting period will most likely lead to a higher premium. Consider how long you can manage without receiving any income before selecting the waiting period for your insurance cover.

Income protection insurance can help you pay your bills if you can no longer work due to a sudden injury or illness. You may consider buying income protection insurance if you have dependent family members or are self-employed and don't have any sick or annual leave provision. However, it's worth checking your super fund for any default income protection insurance cover before buying your own policy. 

You should also check if the default cover in your super is adequate for your lifestyle and if you need to get it extended or buy a separate policy. Purchasing an income protection policy will cost you money, so it's worth considering whether you need it and can afford it. 

If you decide to buy an income protection insurance policy outside your super fund, you can purchase it directly from an insurance provider or through an income protection insurance broker. Irrespective of how you buy your policy, it helps to compare quotes from multiple insurance providers to find a competitively priced deal. However, if you're not sure about the level of cover you need or need some help finding the right type of policy, you could consider working with an income protection insurance broker.

An insurance broker is a qualified professional who'll help you manage the process of securing the right insurance policy for you. An insurance broker can help you find competitive deals from little-known insurers, negotiate with insurance companies on your behalf and even help you file claims. They can explain to you the benefits and drawbacks of various features so that you only pay for the cover you need. 

However, income protection brokers don't work for free, and they generally charge you a fee which is a small percentage of your base premium. You may want to take quotes from different insurance brokers to get an idea of how much it will cost to work with one. Even if you work with a broker, make sure to do your homework by comparing the deals suggested by the broker and reading the Product Disclosure Statement before signing on the dotted line.