Income Protection Insurance protects you by paying an ongoing income if you are unable to work due to illness or injury.
From 1 October 2021, the Australian Prudential Regulation Authority’s (APRA) changes to the insurance industry come into effect. For Income Protection insurance these changes include:
Benefits cannot exceed 100% of your earnings.
Stricter rules surrounding disability to ensure effective controls are in place to manage the risks of longer-term policies. Meaning stricter disability definitions, tiered income replacement ratios, and/or lower maximum benefit ages may come into effect with new policies.
Benefits
Income protection cover pays an ongoing monthly benefit to protect:
your lifestyle by replacing your lost salary so you can continue to meet some of your living expenses and debt repayments, and
your wealth by reducing or removing the need to sell assets to generate cash.
Without insurance, you may need to run down your savings, sell assets, and/or rely on family or Centrelink for assistance. You may find it difficult to maintain your standard of living or pay for the care and medical assistance you need. This can place extra stress on your recovery. How it works Income Protection is capped at covering a maximum of 90% of earnings in the first six (6) months of a claim, and then 70% of earnings thereafter. The calculation of earnings is typically based on annual earnings at the time of the claim (not exceeding the previous 12 months). Some insurers may pay Superannuation Guarantee contributions in addition to the earnings covered.
The payments are taxable income, but tax may not be deducted from each payment. So you should seek tax advice and make sure you set aside money to pay your tax liabilities. If paid through superannuation, tax is usually deducted from each payment to help you manage this obligation.
The amount you receive may also be reduced if you receive payments from sick leave, social security, workers compensation or other legislative sources.
Indemnity policies
With an ‘Indemnity’ policy the amount you receive at the time of a successful claim will be assessed on the basis of your earnings in the 12 months prior to the disability. You will need to provide proof of income at time of claim and if your income has reduced you may receive less than expected.
Effective 1 April 2020, the Australian Prudential Regulation Authority (APRA) implemented measures to address the poor performance of personal income insurance policies. As a result, ‘Agreed Value’ income protection policies are no longer to be offered by life insurance companies. ‘Agreed Value’ policies were found to violate the principle of indemnity, insomuch that an insurance policy benefit should not exceed a policyholder’s economic loss, and an ‘Agreed Value’ policy may enable this.
This change enables income at risk to be closely tied to the individual’s earnings at the time of a claim and further encourages claimants to return to work (where possible).
‘Agreed Value’ income protection policies established (or in force) prior to 1 April 2020 may continue.
Waiting and Benefit Periods
In the event of a successful claim, benefit payments do not start immediately; a waiting period will apply during which no benefit is payable. The waiting period can be as short as 14 days or two years. When choosing a waiting period, it’s important to consider any sick leave and related benefits provided by your employer. The shorter the waiting period, the higher the premium.
The maximum period that payments continue is called the benefit period. A range of benefit periods are available - some as short as one year, with the longest continuing through to your 65th or 70th birthday. In general, the longer the benefit period, the higher the premium.
Policy Ownership
Income Protection insurance can be owned by any person or legal entity provided the owner has an insurable interest in the life insured. Below the most common ownerships (self-ownership and superannuation ownership) are explained.
Self-ownership
Owning the policy in your own name may allow you to better tailor the cover to suit your individual requirements (e.g., to obtain more comprehensive benefits and ancillary benefits). With self-owned cover, you pay the premium from your cashflow. The premiums are tax deductible to you and benefits that you receive in the event of a successful claim are treated as taxable income and taxed at your marginal tax rate.
Superannuation ownership
You may also be able to purchase your cover in your superannuation fund. This allows the premium to be paid by making contributions to super or simply be deducted from your superannuation account balance, so it does not affect your cashflow. The premium is a deductible expense to your superannuation fund and can reduce the tax payable on contributions and investment income. The benefit to you will depend on your superannuation fund.
If additional contributions are made into superannuation to cover premiums it is important to ensure you do not exceed the limits on how much can be contributed.
The proceeds in the event of a successful claim may be paid from your superannuation fund as a temporary illness benefit and will be assessable income that is taxed at your marginal tax rate. You will first need to meet the release definition for superannuation which may be harder to meet than a self-owned policy.
For business owners it may be appropriate for the business to own the cover. This ensures any claim proceeds are paid directly to the business so it can distribute the funds accordingly.
Optional benefits
Income Protection policies may offer important options including:
an Increasing Claims option that ensures benefit payments are indexed in line with inflation
a Superannuation Cover option that allows you to have contributions made to your superannuation fund (above the level of salary cover)
other ancillary and rehabilitation benefits.
Consequences
Funding the premiums from your superannuation balance will reduce the growth of your retirement savings unless you make additional contributions to offset the premiums. These contributions will count towards your contribution caps.
Benefits are paid monthly in arrears so your first payment would be received one month after the end of your waiting period.
Benefit payment is usually excluded if you suffer sickness or injury as a result of war (or an act of war), a self-inflicted act, or uncomplicated pregnancy.
Superannuation providers must cancel a member’s insurance cover in their super if their super account has been inactive, that is, hasn’t received a contribution or rollover for a continuous period of 16 months, unless the member specifically elects to keep their insurance. If this applies to your insurance in your super account, you’ll be sent a notice before any insurance is cancelled. Please make sure your contact details are up to date.
You should always carefully read the Product Disclosure Statement (PDS) and policy document for your selected insurance policy and keep these documents in a safe place.
Stu Varidel and Your Choice Financial Planning Pty Ltd trading as Heart Financial Advisers are authorised representatives of Sentry Financial Services Pty Ltd AFSL (Australian Financial Services Licence) 286786.
The information contained herein is of a general nature only and does not constitute personal advice. You should not act on any information without considering your personal needs, circumstances, and objectives. We recommend you obtain professional financial advice specific to your circumstances. The views expressed here are not ours. While the information contained in this article may contain or be based on information obtained from sources believed to be reliable, it may not have been independently verified. Where information contained in this publication contains material provided directly by third parties it is given in good faith and has been derived from sources believed to be accurate at its issue date. To the maximum extent permitted by law: no guarantee, representation or warranty is given that any information or advice in this publication is complete, accurate, up to date or fit for any purpose; and no party or associated entities as mentioned is in any way liable to you (including for negligence) in respect of any reliance upon such information. This article may also contain links to websites operated by third parties who are not related to us. These links are provided for convenience only and do not represent any endorsement or approval by us.