A classic study by Weinstein (1980) examined how people rated their chances of experiencing certain life events compared to others. People consistently believe they are more likely to enjoy positive outcomes than others and less likely to face negatives, like illness or accidents—despite identical risks. This established our tendency toward ‘optimism bias‘ our inclination to believe that “It won’t happen to me”

But it might. It already has. When you have the support of a working partner you’re somewhat shielded from the negative consequences of not being able to work, but as an independent individual the risk is greater and the consequences more acute, especially if you’re supporting others with your income.

This article will tell you all you need to know about income protection.

What is income protection?

Income protection insurance provides a regular income if you’re unable to work due to illness or injury. It is designed to replace a percentage of your earnings until you can return to work or retire. But there are so many options available that it can be difficult to cut through marketing noise.

What should I look for in a policy?

The quality of the products on offer can vary widely. These are the features that you should insist upon.

  • Premiums which are guaranteed to remain fixed throughout the policy term
  • A ‘long term’ policy which covers you until retirement, death, or recovery and allows for as many claims as required during the term of the plan
  • Increasing coverage – the level of cover and the premium increase each year to ensure your protection keeps pace with inflation
  • If relevant, occupation specific cover. Tailored for your specific profession (e.g., doctors, manual workers)
  • A policy which starts paying as soon as your company’s sick pay ends – this is known as the deferred period and can range from 4 weeks to 2 years

Do I really need income protection?

For some, it’s a MUST:

1. If you are single

In the UK, around 1 million workers are unable to work for more than four weeks each year due to illness or injury and 2.82 million people were economically inactive because of long-term sickness (Statista, 2024).

  • If you are in a relationship the chances of both parties becoming unable to work due to illness or injury is 1 in 222
  • If you are single the chance of you becoming unable to work due to illness or injury rockets to 1 in 15

If you’re in a relationship, with joint responsibility for finances, a shared mortgage, shared bills etc. you are shielded from the acute risks of not being able to work due to illness or injury. If you are going through a divorce or are divorced then you no longer have this protection and the imperative for high-quality income protection goes up, especially if you have an insufficient savings buffer or dependents. Under these circumstances income protection isn’t a privilege, it’s an absolute must to secure your financial security.

2. If you are self-employed or a business owner

The imperative will vary depending on the type and size of your business but, according to the Federation of Small Businesses, 56% of UK businesses are sole traders (2023).  Financial difficulty could arise rapidly if you weren’t able to work, contracts go unfulfilled, and cover is extremely difficult to obtain, adding huge stress at an already challenging time. ‘Group income protection’ normally requires more than 3 or 5 employees so the necessity for individual income protection becomes significant. If you do have more than 5 employees ‘group income protection’ can be an effective and relatively economical way to obtain protection and so can be highly recommended.

3. If you have minimal work-based protection

Some employers offer minimal or no income protection. Over a million people every year are unable to work for four weeks due to illness or injury. That’s a 1 in 42 chance that you won’t be able to work for a month next year. What impact would that have on you or your family? The consequences will vary depending on your level of income, savings and financial responsibilities but effective income protection will guard against any additional financial strain at an already difficult time.

For others, it might be less necessary:

1. If you have excellent work based income protection

Some employers offer awesome protection. Anything more than full pay for 6 months would be considered generous. If you’re fortunate enough to have this level of protection from your employer, then the acute pressure caused by illness or injury is certainly somewhat relieved. Yet 2.82 million working age people in the UK are unable to work for the long term and even the most generous employers have their limits. Longer term protection is therefore still a very prudent investment. The good news is that the income protection you would require, with the cover payable when your workplace benefits cease, is often significantly cheaper to obtain compared to a policy which offered cover from the outset of illness or injury.

2. Permanently ill, near retirement and have a substantial work-based pension

If you’re unfortunate enough to be permanently ill or injured you can apply for ‘early retirement’ on grounds of ill health (called medical retirement), regardless of your age. If you are relatively close to retirement and have amassed a significant amount of money in your pension pot you will probably be able to access your pension early and this, in combination with State benefits or State Pension, may be enough to sustain you throughout retirement. If this reflects your circumstances the imperative for income protection diminishes although we’d recommend running this scenario through a cash flow forecast to be sure.

For everyone, you MUST be aware that:

Long term income protection is a complex policy that is normally only available to people who have received financial advice. Without it the longest claim period you can normally secure is around 2 years. This is better than no protection but doesn’t afford long term financial security and arguably is just kicking a problem down the road. If you seek input from a financial planner they can gain access to higher quality policies and ensure you don’t end up paying for cover that won’t get paid out to you.

What steps should I take to secure income protection?

  1. Assess the cover you need
    • Determine your essential expenses and calculate the minimum income required to maintain your lifestyle in the event you couldn’t work.
    • Seek help from a financial planner in order to achieve precision. They can use sophisticated cash flow tools to determine long-term costs and income needs throughout your lifetime. 
  2. Review Existing Benefits
    • Check employer sick benefits, State support, and your existing savings to identify gaps in coverage and establish the strength of the imperative for income protection.
  3. Customise Your Policy
    • Work with a financial planner to identify level of risk and tailor the right policy features for your situation.
    • Choose appropriate coverage, including income percentage, deferral period, inflation related increases and term length.
  4. Review Regularly
    • Review your policy and ensure it evolves as your circumstances change. It is vital that your coverage remains aligned with your needs.
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References:

Statista (2024) Number of economically inactive people due to long-term sickness in the UK from 1993 to 2024. Available at: https://www.statista.com/statistics/1388245/uk-sick-leave-figures/ (Accessed: 28 November 2024).

Federation of Small Businesses (2023) UK Small Business Statistics. Available at: https://www.fsb.org.uk/uk-small-business-statistics.html (Accessed: 5 December 2024).