If you had a machine in the corner of your lounge room that pumped out $100,000 or $200,000 every single year, would you insure it? Of course you would! If the machine broke down you would want the maintenance guy to come over & fix it as quickly as possible so that it could start pumping out the cash again.
This is why Income Protection insurance is THE MOST IMPORTANT insurance that anyone can purchase, because we are the machines. We are the ones pumping out the money, week after week & if we break down we need to ensure that the money continues to flow.
Income protection insurance provides a monthly benefit for a specified period in the event that you are unable to work due to a sickness or accident. Monthly benefits are paid whilst you are totally or partially disabled, or under rehabilitation. The premium for income protection insurance varies depending on a number of factors that include:
- The percentage of gross salary or earnings covered (up to a maximum of 75%)
- The waiting period before benefits are paid to you (from 14 days to 2 years)
- The length of time the benefit is to be paid (from 2 years to age 70).
- Your sex, age and occupation, and
- Whether or not you smoke.
Income Protection can be a bit of a ‘minefield’, particularly at claim time, if you have not done your homework. So, before we look at how to maximise your benefit payment & minimise your tax liability when you do need to make a claim, here is a very brief overview of the different types of contracts that are available for you in the marketplace:
The type of contract you purchase will depend on the above criteria and also on whether you purchase it from a Life Insurance company or a General Insurance company. You will hear terms used like cancellable, non-cancellable, indemnity, agreed value andaccident only, but what do they all mean?
Cancellable – Normally offered by General Insurance companies, this means that the insurer does not have to renew the policy. This regularly happens after they have paid a claim and often to the disgust of the client who probably did not take the time to read the 60-page product disclosure statement. Try to avoid this style of contract if at all possible.
Non-Cancellable – Offered by Life Insurance companies, this means that only you can cancel your policy, not the insurer, regardless of how many claims you make. Unlike home or motor vehicle insurance, the insurer cannot increase your premiums because you have made a claim either. They will normally only increase premiums as you get older or as your benefit increases.
Indemnity – This means that when you make a claim you will need to provide evidence of your income for the previous 12 months so the insurers can calculate the benefit payable to you. This may not be such an issue if your income is fairly constant and you keep accurate records, however, if you are insured for say $10,000 per month and your income has gone down in the last year due to unforeseen financial circumstances, and you cannot justify that level of cover, then the insurer will reduce how much they pay you. Also try and avoid this style of contract if possible.
Agreed-Value – The insurer agrees to pay you an agreed amount based on the financial evidence you provide at the time of your application. Even if your income reduces due to unforeseen circumstances, you are guaranteed of receiving the insured benefit when you make a claim. A Non-Cancellable, Agreed Value contract is your best option if you can obtain it.
Accident Only – Exactly what it says – you will not be paid a cent if you get sick. This style of contract always leads to trouble at claim time particularly if the insured person was involved, for example, in a car accident that was caused by their asthma attack. Yes they were in an ‘accident’, but the accident was caused by a pre-existing illness therefore they are not covered. Try and avoid these contracts as well.
Many people do not realise it, but some Income Protection contracts will pay a small amount, usually 3-6 times the monthly benefit, if the life insured dies. Certain insurers will pay this out regardless and some will insist that the life insured needed to be on claim at the time. Either way, it is worthwhile investigating this with your insurer as it can often cover the cost of the funeral.
Another word of caution – some Income Protection contracts have clauses that allow the insurer to reduce how much they have to pay you. A typical clause is the “Offset” clause which allows them to reduce your monthly benefit if you receive other disability benefits (not such a bad thing), or other legislated benefits such as worker’s compensation or 3rd party accident payments (this can become complicated), and even if you haven’t yet received those benefits but are entitled to receive them (you are now talking major anxiety attack!!!).
Most professionals should be able to obtain contracts with no offsets other than other income protection contracts where the total benefits received from all insurers would exceed 75% of your income. This is fair enough because there would not be much incentive to return back to work if you could sit on your backside watching Oprah all day and get paid more than what you were earning while you were actually working.
Most office workers and blue collar workers will have offset provisions but make sure that your insurer can only do this if you actually receive the money from the other insurance company. Your total benefit received from all insurers should still be up to 75% of your income if that is what you have paid for (note this is reduced somewhat for higher income earners).
So, now that we have a general understanding of the types of products available, how can we ensure that we receive the maximum benefit allowable whilst at the same time minimising the tax payable? After all, this is the one time when we are going to need as much as possible coming into our bank accounts!
For those who are running a business (via a company or family trust) or those who are sole traders:
Ownership of your Income Protection policy is key. I have lost count of how many business owners I have met in the last 30 years who operate their businesses through a family trust (for example) but have their income protection policies owned in their own names.
When I ask the question ‘why is your business operating through a family discretionary trust?’ I always receive the same response: ‘because my accountant told me to set it up this way’. There is absolutely nothing wrong with this response by the way, but let’s think about this for a moment: the discretionary trust provides the business owner with a layer of protection but what else does it do? It allows the business owner to distribute income to other family members, thus reducing the business owner’s personal taxation liability.
This is a common & sensible strategy, however when the income protection policy is owned personally by the business owner then what happens at claim time? The insurance company will pay 100% of the proceeds to the owner & he/she will have no opportunity to distribute income to family members to minimise tax. In fact, in many cases, the business owner’s personal tax liability will actually INCREASE! Remember, income protection benefit payments are assessible for taxation purposes.
A simple change of ownership of this policy from the business owner to the family trust will allow for the benefit payments to be made to the trust so that distributions can continue even when the business owner is incapacitated. Please make sure you seek advice from your accountant & financial planner before making this change.
Financial underwriting is No 2 on the list of priorities. Financial underwriting is the process of providing financial evidence to the insurance underwriters so that they can offer you the maximum benefit allowable. This will include your previous two year’s tax returns (for yourself, your spouse & your business entity), your profit & loss statements + your balance sheets.
When calculating your maximum allowable monthly benefit the underwriters will not only take into consideration your & your spouse’s taxable incomes, but they will also include things like superannuation contributions, vehicle costs, depreciation etc. This exercise is vital if you want to ensure that you are paid as much as possible when you are debilitated.
Always obtain advice from a financial planner/insurance adviser. I cannot stress this enough!
- An independent planner/adviser is required by law to always act in your best interest; a telemarketer from a direct insurer is required by his/her employer to sell you a product.
- An independent planner/adviser is required to maintain his/her education through ongoing personal development & training; a telemarketer is required by his/her employer to reach their daily call & sales targets.
- An independent planner/adviser will act for you at the point of claim to ensure that the money is deposited into your bank account as quickly as possible; a telemarketer will not be available to assist you with your claim (besides, they will have probably moved to Stanthorpe for the fruit picking season) & it is at this point that you will now be underwritten (let’s hope that you did not fail to disclose any relevant information regarding your medical history when you were told that you only needed to answer 6 EASY questions!!!!)
For those who are employees:
As an employee you may find that income protection is available with your superannuation. This is not a bad option necessarily however your policy will be an ‘indemnity’ style of contract & your benefit payment period will be limited normally to two years. Many Australians will take up this option simply because it is the most affordable.
Some employers will also offer a ‘Group’ income protection contract which is still quite an attractive option, mainly for two reasons: 1) affordability, & 2) the fact that, up to certain limits, you will not be require to provide evidence of health. This is a fantastic option for those with pre-existing medical conditions.
If you are in a position to afford a non-cancellable, agreed-value contract then points 2 & 3 above also pertain to you.
If you need any assistance please connect with or contact me. We have 30 years’ experience in assisting clients with their claims.