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Many super funds provide fund members and their families valuable financial security by offering them cost-effective access to group income protection cover.
Sometimes called salary continuance, income protection (IP) insurance is a type of life insurance designed to provide cover if you can’t work temporarily. It’s often offered in conjunction with death and TPD insurance.
To help you understand what to consider before taking out an IP policy, SuperGuide has put together this simple explainer.
What is income protection insurance?
Income protection cover insures you against the risk you cannot earn an income for a certain period of time due to illness or an injury. It does not apply to redundancies or if you are stood down.
With IP insurance, you are paid up to 85% of your pre-tax income for the period specified in your policy. Receiving regular IP payments allows you to focus on getting over your illness or injury, rather than having to worry about how to pay your bills.
IP insurance can be particularly important if you are self-employed, have large debts, or have a family or dependents that rely on your income.
How does income protection insurance work?
The amount an IP policy will provide if you are injured or become ill is generally either the:
- Indemnity value – A set percentage of your salary prior to your injury or illness.
- Agreed value – An agreed amount selected when signing up.
IP policies inside super are only available with Indemnity value.
The maximum claim amount you can receive through an IP policy is 85% of your pre-tax (and pre-disability) salary. This includes an amount for super that is paid directly into your super account, with the remainder of your benefit being paid into your bank account.
The time limit for the period you can receive payments if you can’t work (the benefit period), is commonly two years or five years. Some policies continue payments until a specific age – usually age 65.
Super funds have different terms and conditions for their IP cover depending on their chosen insurer, but usually you can apply for a policy if you are over age 15. Cover is generally not available inside super after age 65-70.
What does IP cover cost?
Premiums for income protection insurance – particularly outside super – are normally either:
- Stepped – The premium usually rises each time the policy is renewed, as the chance of a claim increases as you get older.
- Level – The premium is higher at the start of the policy but doesn’t increase as you age.
IP cover inside super is usually unit-based and funds generally offer units at a set price per unit.
In an IP policy, the benefit payment is usually limited by your income in the 12 months before your temporary disability. The actual amount you get depends on whether you meet the insurer’s definition of disablement or partial disablement and whether you have already received any other benefits such as paid sick leave, social security or worker’s compensation.
What you need to know about claims and waiting periods
Most IP policies have a waiting period before you receive a payment and these are usually 30, 60 or 90 days. The shorter the waiting period, the higher the premium you need to pay.
To receive an IP payout, you need to satisfy the insurer and trustee that you have met the disablement definition in your policy. This can be controversial, with some policyholders feeling they have been denied a rightful claim. The latest complaints figures from AFCA show 35.8% of the life insurance complaints it received to 30 June 2020 related to IP policies.
According to APRA’s most recent statistics, however, in the 12 months to 30 June 2020 group super IP policies had a 96% acceptance rate. Only 5% of IP claims were declined across the whole industry, with the main reason being the IP insurance contract’s definition was not met when the claim was made.
How much IP cover do I need?
Working out how much IP cover you need and what it will cost is fairly straightforward:
Step 1: Work out your monthly salary
For example, if your salary is $72,000 per year, divide your salary by 12 for a monthly amount ($72,000 / 12 = $6,000 per month).
Step 2: Calculate 85% of your monthly salary
Using the example above, 85% of your monthly salary is $5,100 ($6,000 x 85% = $5,100 per month)
Step 3: Calculate the number of units of cover you need
If your super fund offers a unit of cover for $250, calculate the number of units you need to match 85% of your salary ($5,100 / $250 per unit = 20.4). Round this up to 21 units of cover.
Step 4: Calculate the cost of your cover
For example, your fund’s cover costs $0.2545 per unit for your age if you take a 30-day waiting period and a benefit is paid for two years and you are classified as undertaking non-manual work.
In this example, the cost of your cover would be $5.35 per week ($0.2545 x 21 units). You would receive 75% of your benefit in your bank account ($3,825 per month before tax) and 10% ($510 per month) would be paid into your super account.
Step 5: Consider your cover options
There are ways to reduce the cost of your IP cover. For example, the $5.35 premium cost would be reduced if you chose to increase the waiting period from 30 days to 90 days. Alternatively, you could choose a shorter benefit period.
The key is to work out how long you and your family could survive without your income if you became ill or injured for a time.
Tax and income protection policies
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.
Generally, the ATO permits you to claim the cost of income protection premiums if they are bought as a standalone policy outside your super fund. If you pay your premiums inside super using your super contributions, they are not tax-deductible.
Do I need IP protection inside super?
Income protection inside super works well for people on tight budgets, those with limited disposable income, or anyone who cannot get a policy outside of super.
IP can provide valuable protection if you have a partner, young family or significant financial commitments. It can help pay the bills or your mortgage for several months while you are off work, which might otherwise be difficult for most families.
Older workers nearing retirement usually have less need for income protection, but this can also apply to part-time workers or those with multiple super accounts.
IP policies inside super tend to have fewer features than policies outside super. Standalone IP policies sometimes offer valuable additional benefits such as accommodation, transport and childcare benefits, home assistance, critical illness benefits, nursing care, elective surgery and counselling support.
If an IP policy inside super doesn’t meet your needs, consider purchasing one outside super with an Agreed value (a set monthly benefit payment) and link the two policies. This can be valuable if you change jobs or have a reduction in your income after taking out your IP policy. By linking the two policies, your claim can be assessed against both the super and non-super policies.