Contractor income protection provides a vital source of income if you have an accident or become too ill to work. But how much do the premiums for this essential financial survival tool cost?
No one premium is the same, as they are dependent on each contractor’s personal circumstances, including their health. They are in fact quite small compared to your earnings but the consequences of not being insured are huge. Are you covered?
What type of income protection provider should contractors choose?
Firstly, you need to consider the provider. A financial adviser should provide guidance, but sometimes premiums can be attractively priced for a reason.
For income protection over the long term, you should avoid the old style mutual and friendly societies. They should be avoided as they simply lack financial reserves.
In this context you get what you pay for and a large provider with a well known brand is the best option, as they will be sufficiently capitalised to provide for policyholders over the long term and will have efficient processes for when you need to make a claim.
What amount and time period should you choose?
The next decision is for you to choose how much you would need each month and after how many months you would make a claim. Essentially, these will link directly to your earnings and how much cash savings you have.
You can only insure up to 70% of your gross taxable earnings using income protection, and most contractors choose three, six or 12 months as the time period after making a claim before payment starts.
There are one or two providers who will start paying out after a week, but this increases the premiums. At the other end of the scale, you can choose to be paid after two years from becoming ill, but these policies are not attractive to most contractors.
The longer the period, the lower the risk to the provider and the greater chance of the contractor recovering and not needing a payment, so the premiums are weighted accordingly.
How much premium you can pay for income protection
Here are some sample premiums based on a contractor who is a non-smoking male aged 31 with no additional health issues seeking £1500 a month. The example premiums are as follows:
- £21 per month premium for an income protection policy that pays £1500 a month after 12 months
- £23 per month premium for an income protection policy that pays £1500 a month after six months
- £44 per month for an income protection policy that pays £1500 a month after only one month.
The tipping point in premium costs is around the one to three month mark. Most contractors choose amounts of £1500-£2000. If a contractor wants to insure for a much higher monthly income, then their premiums will also be considerably higher. But remember you can only insure up to 70% of your gross taxable earnings.
How do payment protection insurances actually work?
If you have an accident or get ill, then the minute the doctor signs you off, you make a claim. If the deferred period is three months, then the provider will start paying out in month four, assuming you have not recovered by then.
The policy does not end when you make a claim. If, for example, you have a 25-year policy to take you to retirement and you must claim in year three, that does not stop you from claiming again in year five.
You can also choose a guaranteed renewable premium that stays the same so you know where you stand after the underwriting has been completed.
It is also possible to index link the policy, so the cover is inflation-proof. £2000 today is worth less than £2000 in five years time. If you choose this option, every year the premium increases in line with inflation, but so does your cover.
What other factors affect income protection policy premiums and payouts?
There are three major factors that can make an impact on your premium and potential payout: Health is a major factor and if there is any condition that means there is a higher risk of you being more likely to take time off work due to illness, it will increase premiums. This can include factors such as general wellbeing – a contractor with a high body mass index (BMI), for example, will have a higher premium.
There is also the type of job you do. Many contractors work in offices, so have low risk occupations. But oil and gas contractors spending time offshore and engineering and construction contractors spending time on construction sites can expect to pay higher premiums.
Finally, the income protection payout is typically based on gross taxable earnings. This does not work if a contractor is working for one of the more tax efficient umbrella companies or offshore solutions because their gross taxable earnings are so low, although it does work for limited company contractors with low salary and high dividends.
What the examples highlight is that for most contractors, income protection is easily affordable, and even for contractors with occupation or health-related issues, when compared with typical earnings a policy is a small overhead compared to the peace of mind you and your family get if the worst happens and you can’t work.