A guide by Broadbench on the ins and outs of income protection in a contractor setting.
Income protection insurance is a financial lifeline for anyone who doesn’t have the benefit of employer-provided sick pay.
Typically, it’s the self-employed, business owners and contractors who go without such Statutory Sick Pay.
Income protection comes into its own when illness or injury strikes because if you’re one of these three individuals and become unable to work, this tax-efficient cover steps in with a financial buffer, writes Tom Hitchcock, managing director of Broadbench.
When do contractors receive income protection payments?
Income Protection (or ‘IP’ for short), financially covers you when you can’t work by ensuring you receive a regular income to cover essential bills.
You’ll receive the payments until you’re fit and able to return to work.
Sometimes, steely contractors think that spending a long time on the bench doesn’t apply to them!
Stability vs hardship
But did you know that approximately 1 in 5 men, and 1 in 6 women, will suffer a long-term illness in their lifetime?
In a world where too many of us are just a few weeks away from financial difficulty, income protection can be the difference between stability and hardship.
According to Aviva, nearly one in three UK adults have experienced leave from work due to unexpected ill health or the death of a long-term partner.
Why income protection is a must
Out of these, 77% (that’s a significant 12.3 million people) have seen their finances suffer as a consequence.
The idea of suddenly being unable to work due to illness or injury is daunting for most people.
Without a steady income, how would you manage expenses such as rent, mortgage, or utilities?
This is where income protection insurance becomes essential, providing peace of mind that even if you’re unable to work, your financial obligations will be met.
Income protection doesn’t cover contract cancellations; it solely addresses your inability to work due to illness or injury.
Six reasons to put an income protection policy in place
1. Illness is the biggest financial risk
Many people prioritise life insurance, but the reality is that illness is a far greater risk during your working life.
Income protection helps you manage this risk by covering a wide range of medical conditions that prevent you from working.
2. Covers ANY illness
Unlike critical illness insurance, which covers only specific severe conditions, income protection pays out for any illness or injury that leaves you unable to do your job as a contractor.
This makes it a more comprehensive option.
3. Ongoing payments
Instead of a lump-sum payout, income protection provides a steady monthly income for as long as you are unable to work.
This means that your bills will continue to be covered, no matter how long your recovery takes.
4. Government support is minimal
Relying on government support is not a realistic solution in the eyes of most contractors we speak to.
Statutory Sick Pay (SSP) offers just £109.40 per week for up to 28 weeks, and for the self-employed, there’s no SSP at all.
Employment and Support Allowance may be available, but it often falls short of covering essential expenses.
5. Protects your savings
Even if you have built a savings cushion (a ‘war chest’ in contractor parlance), depleting it during an extended period of illness can have long-term consequences.
Income protection keeps your savings intact, allowing you to rely on the policy rather than your hard-earned savings.
6. Income protection is cheaper than you probably think
Contrary to what many often believe, income protection is surprisingly affordable and customisable.
Tell them you want value-for-money income protection, and a financial adviser can help you tailor a plan that suits your budget and lifestyle.
And yes, we are one such adviser!
What to look out for: Income protection key policy features
When considering income protection, there are several important features to take into account:
- Premium types: Choose between level-guaranteed premiums (which remain consistent throughout the policy) or age-costed premiums (which start lower but increase over time).
- Claim period: A long-term claim period could allow payouts until retirement, but a limited claim period, such as two or five years, can reduce your premiums.
- Waiting period: The length of time you wait before payments begin can vary. A longer waiting period results in lower premiums.
- Occupation type: The policy’s payout criteria depend on your occupation. The most comprehensive coverage is “Own Occupation,” which pays if you’re unable to do your specific job. But be aware, it’s also the most expensive.
- Increasing cover: Opt for “Inflation-Linked Increasing Cover” to ensure that your benefits keep pace with the rising cost of living.
How much income protection do you need?
The financial amount of coverage you need depends on your monthly expenses.
Most income protection cover policies suitable for contractors replace 50-70% of your pre-tax income, including salary and dividends.
If you’re fortunate enough to save regularly, you may not need full coverage, but income protection is there to safeguard your finances in the event of long-term illness or injury.
Reassuringly, 92% of claims were paid to a total of £9.9million in 2022, according to Exeter statistics.
Income protection, are there tax considerations?
Payouts from income protection insurance are typically tax-free if you pay the premiums yourself, as an individual.
However, if your business such as a limited company pays for the policy, the payouts may be subject to tax.
Consulting a financial adviser will help you understand the tax implications of income protection, and fortunately, most advisers know that tax-efficiency matters to their clients.
Income protection vs critical illness insurance, what’s the difference?
Before you go shopping for either, it’s important to differentiate between income protection and critical illness insurance.
While income protection helps cover your income during a temporary illness, critical illness insurance provides a lump sum for severe illnesses from which recovery might be uncertain.
Both have their place for contractors in a comprehensive financial plan.
However, income protection is vital for ensuring regular income during recoverable conditions.
What about Executive Income Protection?
Executive Income Protection (EIP) is a tax-efficient benefit for both employers and employees.
Typically paid by the employer, EIP is tax-deductible and not classified as a P11D benefit, so employees don’t incur additional tax.
Premiums qualify for corporation tax relief, making it attractive for small and medium-sized businesses to retain key employees.
EIP policies offer coverage up to 80% of income, which is more generous than personal policies, and can also cover National Insurance, pension contributions, and even a spouse’s dividends (if they don’t drive profits).
With flexible payout terms and options for index linking, EIP provides valuable income security.
However, tax treatments of employment benefits can change! So it’s always best to consult with your financial adviser before taking out Executive Income Protection.
Tax-efficient insurance for when you can’t work: in a nutshell
For business owners, contractors, and the self-employed, income protection insurance is a must.
It safeguards your financial future, ensuring that illness or injury doesn’t disrupt your livelihood.
With its affordability, flexibility, and tax efficiency – pending that chat with a financial adviser, income protection offers essential peace of mind.
If you’re without the luxury of employer-provided sick pay, it’s a crucial investment in your financial stability and provides invaluable peace of mind.
Find out more about Contractor Income Protection
Get in touch with our IFA partner, Broadbench, to find out more or to get some policy quotes. We’ve worked with Broadbench for over 5 years – they’re contractor specialists with excellent customer service.
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