Income protection insurance inside super: Choosing the right level of cover

The amount an IP policy will provide if you are injured or become ill is generally a set percentage of your earnings prior to your injury or illness. In the past, policies outside super could provide ‘agreed-value’ payments where you would be paid a set amount that was not linked to your actual earnings, but this has been prohibited for new policies since March 2020.

The maximum claim amount you can receive through an IP policy is generally 85% of your pre-tax (and pre-disability) salary. This usually includes an amount for super paid directly into your super account, with the remainder of your benefit being paid into your bank account.

The monthly benefit shown on your super statement is the maximum amount you can receive, with the actual amount calculated by the insurer when you make a claim, based on your earnings in the period before your disability occurred. 

If you are receiving income payments from workers’ compensation, paid sick leave, Centrelink benefits or other insurance when you claim on your IP policy, the amount you receive from your IP insurance may be reduced. This depends on the policy terms, which are outlined in your fund’s insurance guide.

The time limit for the period you receive payments if you can’t work (the benefit period) is commonly two years, five years or until you reach age 60 or 65. There may be a range of benefit periods you can choose from. 

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 you need to know about claims and waiting periods

Income protection policies have a waiting period before you receive a payment, usually 30, 60 or 90 days. The shorter the waiting period, the higher the premium you pay.

No payments are made for the waiting period, and when the insurer accepts your claim, your payments are usually backdated to the end of the waiting period.

To receive an IP payout, you need to satisfy the insurer and trustee that you have met the disablement definition in your policy. You need to be ‘totally disabled’ according to the policy definition, which typically means you need to be:

• Unable to do the important duties of your current job because of an illness or injury
• Under the care of a doctor for your illness or injury
• Not doing any other form of work.

Making a claim will require you to complete a claim form and provide a statement from a doctor that you are unable to work. You may also need to provide additional medical evidence, such as your medical records, or undertake an assessment with the insurer’s chosen doctor.

If your claim is accepted, regular monthly medical evidence is usually required to ensure you remain eligible for the IP payments.

The insurer may also ask for proof of your pre-disability earnings.

How much IP cover do I need?

The monthly IP benefit you need depends on your regular expenses, including debt repayments and the cost of supporting your family.

If you’re currently spending most of what you earn, you’re likely to need the maximum amount you can apply for, which is commonly 85% of your income, with 75% paid to you and 10% paid into your super account.

If you usually have significant excess earnings to save or invest, you may apply for a lower insured amount based on your necessary monthly spending. Remember to consider the additional cost of an illness or disability that is serious enough to keep you away from work for more than 30 days.

Once you have calculated the monthly benefit you need, it’s time to consider the benefit period and waiting period you will choose. Most super funds offer a range of options.

The appropriate waiting period for you depends on the savings you could use to support yourself before your income protection payments start and the paid sick leave you have available. If you have minimal savings and sick leave, you’ll need a shorter waiting period.

When you have a bigger buffer, you may be able to choose a longer waiting period. Keep in mind that shorter waiting periods come with more expensive insurance premiums.

To choose an IP benefit period, you need to consider that your income protection policy should work in combination with a TPD policy that will provide a lump sum payment if your illness or injury makes it unlikely you will be able to return to work.

Income protection with a benefit period up to age 60 or 65 means you don’t need as much TPD cover because if you’re permanently disabled, you will continue to receive monthly IP benefits until your 60^th or 65^th birthday.

A benefit period of two years (or another shorter period) means you will need more TPD cover because your TPD policy will need to provide for all your income needs from the time your IP payments stop until you reach retirement age. A shorter benefit period means lower premiums and a longer benefit period is more expensive.

Shopping around 

If your super fund’s income protection offering doesn’t suit your needs, it’s worth looking around for an alternative fund or a policy outside super.

Most super funds have modernised their insurance policies to provide the flexibility to select a tailored level of cover and choose from a range of benefit and waiting periods, but yours could be lagging.

Check the super funds with the lowest income protection premiums and do some research about the range of benefits and waiting periods offered by each fund.

Tax and income protection policies

IP benefits are usually deemed assessable income by the Australian Taxation Office (ATO) and taxed at your marginal rate, regardless of whether you hold your cover inside or outside super. 

Generally, the ATO permits you to personally 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 they are not tax deductible to you personally, but your super fund will claim a deduction. The benefit of the deduction is passed back to your super account via a reduction in your contributions tax or as a separate credit.

You can also make personal tax-deductible contributions (or salary sacrifice) to super to pay the premium, if you have space available under your concessional contribution cap.