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Income protection (IP) is available through about a third of super funds as default cover. It is sometimes called salary continuance insurance. It is one of three kinds of insurance available inside super, the others being life and TPD.
This article addresses how IP insurance works inside super, its effectiveness, key trends, claims and how you can establish the right cover for you.
See also our guides on life insurance and TPD insurance. or learn about the benefits and drawbacks about purchasing insurance through your super.
What is income protection insurance – how does it work?
Income protection insures against the risk that you cannot earn an income for a certain period of time due to an injury or illness. It does not apply to redundancies.
Super funds vary in their terms and conditions, but generally you can get IP if you are under age 65 and at least age 15. Cover will cease between the ages of 65–70. The maximum amount you can insure is 85% of your pre-tax (and pre-disability) salary, or up to a monthly figure of $25,000 or $30,000 typically. That 85% would include an amount for super, which would be paid into your super account, while the rest of the benefit is paid to your bank account.
The cost of income protection tends to be highest in the age 50-60 bracket, then will fall after age 61. The benefit period, meaning for how long you can receive payments if you cannot work, tends to be either two years (most common), five years, or until age 65.
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The cover is usually unit-based – a fund may offer you cover in units of $250 per unit, for example. Many funds will not offer income protection if you work less than 15 hours per week or have intermittent work patterns.
Default cover means that it applies automatically when you join a fund and the premiums are debited straight from your super balance, not your bank account. Income protection is less common that life insurance and TPD inside super, but more funds seem to be offering it as a default cover with life and TPD. If it is not part of default cover, just about all funds offer it as an optional extra.
Read our article on the 20 cheapest funds for income protection insurance to get a feel for premium costs and the cover available.
Getting cover – crunching some numbers
Figuring out how much cover you need is fairly simple. Follow these steps.
Assume your salary is $72,000 per year and your fund offers $250 per unit of cover. Divide your salary by 12 for a monthly amount.
$72,000 / 12 = $6,000 per month. 85% of that is $5,100.
The number of units of cover you would need is: $5,100 / $250 per unit = 20.4
Round this up to 21 units of cover. Let’s say your fund offers $0.2545 cost per unit for your age with a 30-day waiting period with a benefit of two years for a non-manual work classification.
The cost of your cover will be $5.35 per week ($0.2545 x 21). You would receive 75% of the benefit ($3,825 per month before tax) and 10% ($510 per month) would be paid into your super account.
That weekly cost of $5.35 can be reduced a fair amount if you chose a 90-day waiting period instead of a 30-day waiting period. You can choose your waiting period and benefit period, but the fund will automatically change your premium cost when you move into a new age bracket. Jump online to your fund website to see what is available and what cover you may already have inside default.
You need to decide how long you and your family can survive without your income if you were to become ill or injured for a period of time. Assess your cash flow and financial commitments, such as mortgages and other debts, before you apply for any cover.
Claims, waiting periods and taxes
Based on past statistics, the average IP claim is around $20,000 in Australia. Waiting periods tend to be either 30, 60 or 90 days, with the shorter the waiting period, the higher the premium you pay.
According to MoneySmart, across the industry the claims acceptance rate for 2017/2018 was 96.2%, and the average claim time was 1.7 months. This can vary significantly by insurer though.
To receive a payout you need to satisfy the insurer and trustee that you have met their conditions for release. The longer the benefit period, the higher the premiums.
The benefit is usually limited to what you earned 12 months before your temporary disability. A claim, and the amount you get, depends on whether you meet their definitions of disablement or partial disablement, and whether you have already received any other benefits such as paid sick leave, social security, worker’s compensation or other similar payments.
Income protection benefits are usually assessable as income and taxed at your marginal tax rate, regardless of whether you hold the cover inside or outside super. The premiums are not tax deductible for you inside super, but the fund can claim a deduction and may pass this onto you depending on how they account for this according to ATO rules.
Read closely the insurance PDS document available on the fund’s website for terms and conditions.
If for some reason you are not happy with an income protection situation inside super, the first step is to contact your fund directly and raise your issues. If this doesn’t help, you can then contact the Australian Financial Complaints Authority (AFCA). This may help if you believe premiums were incorrectly calculated, any information was misleading, or a claim has been denied, for example. A final step would be to engage a lawyer in extreme cases, but ideally due to the cost and stress involved, this is not a desirable option.
Who needs it the most inside super?
Income protection inside super can work well for those on tight budgets, with limited disposable income or who cannot get a policy outside of super. Many super funds are now offering occupational rehabilitation services at no charge if you were to suffer an injury or illness, helping you get back to work more quickly.
IP is also important for those with spouses, young families and significant financial commitments, particularly those in or reaching their full income-earning peak. Several months or more off work can make living or mortgage expenses more difficult to meet.
Older workers nearing retirement obviously have less need for income protection, but potentially so do workers with smaller working hours, multiple super accounts or irregular attachment to the workforce.
The recent report by the Productivity Commission found that some members are being defaulted into insurance products they can’t claim on, particularly IP cover.
A normal full-time worker may see insurance erode their super balance by 7% (approx. $60,000) if they have income protection cover, compared with just 4% (approx. $35,000) if they only have life and disability (TPD) cover. It is not uncommon for many younger workers to take on various part-time or casual jobs in their late teens and twenties, which can generate multiple super accounts.
The Productivity Commission found that balance erosion for low-income members due to insurance could reach a projected 14% of super balances in many cases, and for low-income members with irregular work hours and several multiple income protection policies, it could be at least a quarter of their entire super savings! If these workers have risk-loaded premiums because they are in light blue-collar roles and paying for income protection insurance, they could be 28% (approx. $125,000) worse off at retirement than if they had no insurance.
Other options to consider
IP policies in super tend to have less features than a policy outside of super, which may offer additional and important benefits such as accommodation and transport benefits, child care benefit, home assistance, critical illness benefits, nursing care, elective surgery, and counselling support services.
You may find that IP inside super doesn’t meet your needs, so purchasing a policy outside of super, and linking the two policies may be of benefit. The policy outside of super enables you to have Agreed value, which is a monthly payment (benefit) that you agreed upon when you applied for the policy.
This is handy if you have changed jobs or reduced your income after taking out your policy. IP inside super only offers Indemnity value, which is based on your income at the time you make a claim, meaning your benefit will be less. By linking the policies, your claim can be assessed against both the super and non-super policies, enabling you to receive the full payout rather than a reduced amount.
Income protection inside super may be maligned at times, but if you have family and financial commitments, any kind of coverage is well worth considering. Talk to your financial adviser as to how income protection aligns with other potential insurances you may need, such as life and TPD, whether inside or outside super.