I want to talk about protecting yourself and your small business with income protection. This series we’ve been talking about creating certainty in times of uncertainty, and I want to focus particularly in today’s episode about how you can support your small business by protecting your income with income protection.
As I’m writing this we are also in Mental Health Awareness Week, and I think this fits in beautifully with the link between mental wellbeing and financial wellbeing. Financial anxiety can be caused in situations when we have a loss of income, and not having strong financial foundations. We can be rocked significantly by the loss of a job or if you’re poorly and you’re unable to work. Many of you will have experienced some of this financial trauma recently during Covid-19, so there’s really never a better opportunity to be talking about this subject of income protection. I’m going to specifically focus on income protection for small business owners because usually when you’re employed you get a whole heap of benefits. When you work for an organisation you get holiday, you get sick pay benefits. Sometimes that is statutory but you still get sick pay benefits.
But when you’re self employed you don’t get any of those things. So it’s really important to be looking at what income protection do I need? Do I need any at all? How much cover do I need? How much is it going to cost me? How does it work? So I’m going to cover all of these typical common questions around income protection.
Jump to Section
- What is income protection?
- Do I need income protection?
- What Impacts the costs of income protection insurance?
- Other factors to consider
- How much does income protection cost?
- How much cover do I need?
- What isn’t covered?
- What do I need?
What is income protection?
Income protection is an insurance that pays out a monthly benefit, essentially to replace your income if you’re unable to work. When you’re self employed, your income obviously will be largely dependent on you working in your business, particularly for a small business owner, and your income may vary. The way that insurance works for self employed people is that it will be dependent on what you are earning. Some insurance companies will base it on your tax returns, some of them will base it on your current income and you just have to provide evidence of what that income is. But essentially the insurance will aim to replace that income if you can’t work because of a physical illness, mental illness, or an injury.
Those of you who have followed me for quite some time might remember in January 2019 I was off work for a month. I was in hospital for a week as I had sepsis and a 10 cm abscess in my pelvis. I had a week in hospital and then I had three weeks basically working on my laptop from bed. I was very fortunate in that I have income protection but I didn’t have to use it. I also have personal health insurance and I actually had a payout from that of around £700 because I was in hospital for seven days. Financially, many of my income streams continued while I was in hospital, and one of the benefits of having different semi passive income streams is that some of those income streams may continue even though you’re not working specifically.
So I was quite fortunate, but had that have gone on for longer, I definitely would have had to have restructured my business, or change things around so that that income could continue. That would have put a huge pressure on my financial wellbeing and my mental wellbeing, and I would want to be in a position where I could continue to have that income coming in without me having to worry. So that’s exactly what income protection is designed to do, is to pay. It pays out a tax free monthly amount, after a certain period of time. And they call this a deferment period. The minimum deferment period is normally four weeks. So that stops anybody from making a claim on their insurance if they’ve got the flu or a cold or something that’s perhaps short term. But if it’s longer term, anything longer than four weeks and you’re still off work, then that’s when you would make a claim to pay that benefit out on an income protection policy.
Do I need income protection?
The first question that I would ask of yourself is, do you rely on your income or does anybody else rely on your income? That may sound like a really obvious question, but if you are unable to work, could you still financially manage? Could you still financially pay your bills? So if you’re in a relationship or you’re married or you’re living with a partner: if you couldn’t work, how would that financially impact on your family? You may think I’ll just focus on building an emergency fund and I maybe don’t need to have the cover. But if there is any element of financial contribution that would impact on your lifestyle, then that’s the first question to ask yourself. What impact would it have?
The second question is, how do you feel about that? For us, for example, if I couldn’t work financially, there’s no more holidays, no more treats, no more renovation work that we want to do. None of that would happen without my income. We could still financially survive, but we could literally just survive and we would have no money to do anything else. So financially, I know I would not want that to happen, but also financially for me, I’m a mum of two now. I do the school run every day, obviously not right now. When we will get back to normal what would your partner do? If you don’t have a partner and you’re living by yourself with your children, then you are fully reliant on doing that school run. And if you can’t do that, then it may be that you have to get an Au Pair or a nanny, or ask a friend. But that would have a significant impact on your wellbeing, not just financially, but mentally. You may need to replace your income because you’re going to have to meet the costs of additional things that you may not be paying for at the moment. So think about those scenarios and think about would it have a financial impact? If it would, then by how much?
If you’re self employed, clearly you don’t get any sick pay benefits, so this would have a significant impact. And without any self-employed income protection at all, you’re leaving yourself open to potential risks. And I don’t know about you, but I want to have peace of mind and financial security and my income protection policy is not expensive.
I pay around £56 per month for my income protection. As my income grows that may increase, but I don’t replace my entire income because I don’t need to. I just need to replace as much so that I can feel financially secure. So when you’re looking at income protection, you don’t have to replace your entire income, you replace a percentage of it. And actually insurance companies don’t allow you to replace a hundred percent of your income anyway because then there’s no reward or there’s no incentive for you to go back to work. So they typically will only cover you between 50%-70% of your gross income.
What Impacts the costs of income protection insurance?
The older you are, the more expensive it will be to provide you with the same level of equivalent cover. The income protection for a 35 year old will be more expensive than for a 25 year old for example. So the earlier you take it out, the more cost effective it is for you in the longer term.
Your income and how much you have covered is also a significant determination as to what you’re going to pay. As I said, the most important thing is to think about how much cover do you need as a minimum. So is it that you cover the cost of your bills? Knowing that if you are unable to work, at least your bills could be covered might be something to think about.
When you go through an underwriting assessment for an income protection policy, whatever your job is will determine how at risk you are of being off work because of an illness or injury. So for example, if you’re a builder and you work up on a scaffolding units, it’s going to be much more expensive to cover you than if you’re a coach and you’re working from home, for example.
Clearly if you’re a smoker, you’re at a higher risk of health conditions. So therefore smoker status would be more expensive. And if you have an existing income protection insurance or you’ve stopped smoking in the last 12 months or intend to then review your insurance because it is quite significant impact on your premium, whether you’re a smoker or a nonsmoker. So if you have an existing policy and you’ve now stopped smoking, go and review that policy. If you are a current smoker and you want another reason to stop smoking it will be a significant drop if you stop smoking, but you’ve got to stop smoking for at least 12 months.
Other factors to bear in mind are:
The amount of cover
The deferment period
Normally the minimum deferment period is four weeks, but you can extend that out. So if you had an emergency fund of three months worth of your income, you could increase that deferment period to six months and you could rely on using your savings first. And then once that’s all gone, you could then make a claim on your insurance policy. Now that, again, does have quite a significant impact on the cost. So the longer the deferment period, the cheaper that income protection policy will be.
You typically have short term policies and long term income protection policies. Short term policies tend to be between two years and five years. So the policy would pay out for a maximum of up to two years or five years. So if you were off work and you couldn’t work, because let’s say you broke your back and you were off for a couple of years, a short term income protection policy would pay out that benefit for between two and five years. A longer term income protection policy would pay out for longer. And typically a long term income protection policy would pay out until you go back to work, which might be 3 years, or it might be 20 years. You may never go back. And the end point of that protection policy would normally finish at retirement because at retirement you’d have your state pension which would kick in for income and then any other personal pension contributions you have. So therefore you would not need that income protection policy.
That’s another reason why it’s great to have income protection because you can still then make contributions to your investment pots and your pension pot because you’ve still got income coming in. Therefore it’s not going to have an impact on your long term financial future.
Your current health will have an impact on your premium. When you go through an underwriting assessment, they will ask you questions about your health. Potentially the insurance company may say, well, because you’ve had a problem with your back before, we’ll disclude you from making a claim on your back. They may not, it depends on the severity. If you’ve suffered with depression before, they may not cover you for depression, but there’s not a general rule across the board. It’ll just be dependent on the underwriter’s decision. And you’ll know that before you accept the terms of the policy. Sometimes they’ll decline you outright if you’ve had significant health problems in the past, but don’t make that a reason why you shouldn’t apply. Have a look at it first, and have a look at their decision first.
Guaranteed policy or reviewable policy.
So a guaranteed income protection policy basically means that once you’ve made that application, you’ve been successful, you’ve agreed to commit to that policy, and you’ve started paying your direct debit, your policy premiums will not change. It’s not like your home insurance or car insurance where it’s renewed every year. It stays exactly the same amount for the full term of the policy. If you have a reviewable income protection policy, then the premiums and the cost are reviewed.
In most situations a guaranteed policy is always better because you know exactly how much you’re paying. The underwriters can’t change the cost of that policy, so if your health changes it doesn’t matter because the policy has already been underwritten. The company that we’ve recently partnered with, Anorak, only do guaranteed policies. When I was a financial adviser at the bank, we only recommended guaranteed premiums.
How much does income protection cost?
The cost will be driven very much by all of those factors above. But typically, just to give you an idea, depending on your income, a typical 35 year old female would expect to pay somewhere around between £30 and £40 per month for a good level of cover.
Statistically you are 3x more likely to be sick than you are to die during your working life. How many of us have life insurance but don’t have income protection when you’re self employed? Everybody has life insurance, but very few people have income protection in comparison. One of the blocks that people have around income protection is an idea that they don’t pay out. Policies don’t ever pay out. Based on the stats from 2019, insurance policies paid out 98.3% of the time for claims. So a very, very high percentage of claims made were paid out, and of the less than 2% that weren’t the reason was nondisclosure. Nondisclosure basically means that when you take out that insurance policy, if you fail to disclose that maybe you’ve had an operation in the past that you forgot about, or you were off work because of stress, that’s nondisclosure. So as long as you’re open and honest with your answers, then you’re not going to fall under the nondisclosure trap.
The biggest claims last year were for musculoskeletal, followed by mental health, followed by cancer. Yet most of us think that cancer is the biggest claim under insurance policies, but it’s musculoskeletal such as bad backs. I personally have suffered with all sorts of musculoskeletal problems over the years, so I can really resonate with that. But if I was unable to work because of that, then this would be the type of example where my insurance policy would pay out. The average payout is £17,700. So if you’re paying £30-£40 per month, the average payout is £17,700. That just goes to show you the significant time that people are off work because of musculoskeletal issues, mental health issues, or cancer.
How much cover do I need?
This goes back to one of my core principles. Get financially naked and look out your outgoings and assess them. Write down all of your expenses if you haven’t already done this. Grab a highlighter pen and highlight all the ones that would cause you a significant financial impact if you were unable to pay those. Then you can sit back and think about how much cover do I need?
What isn’t covered?
Income protection does not cover you if you fail to disclose certain health conditions, and it will not cover you for self-harm. So suicide, drug abuse, and that kind of thing.
What do I need?
As I mentioned earlier, I’ve just partnered with Anorak who are absolutely fabulous. They are a company that’s funded by AXA, and they won an award two years ago for the most innovative protection provider. Anorak have a team of financial advisers who will give you personal recommendations based on what you need. They’ve got a free assessment tool you can use, and are fully authorised and regulated by the financial conduct authority (FCA). So they will give you financial advice for your specific needs.
Now I’ve been through their whole process on their app. It’s fabulous. It’s so easy. If you are interested in understanding more about your needs, then if you head over to the The Panel on my website you’ll see some details about Anorak and you can click straight into their free assessment.
If you’ve got existing policies that you want to have reviewed, they will also do that for you. So whether you’re wanting a review of your existing insurance arrangements or looking at creating a new one for your small business and to protect your income, they will look at both.
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