What Is Income Protection Insurance and How Does It Pay Out?

Key things to know

1. Income protection pays a monthly benefit, usually a share of your pre-tax salary, if illness or injury leaves you unable to work.
2. Deferred periods of four, 13, 26 or 52 weeks are common; the longer you wait before payments start, the lower the premium.
3. Benefit periods of two or five years, or longer, are typical; payments stop once you go back to work or the benefit period runs out.
4. If you pay the premiums yourself, payouts are generally tax-free; employer-funded group payouts are usually taxed through PAYE.
5. Some policies only pay for severe or permanent disability, so check how a policy defines incapacity before you buy.

Income protection insurance pays a regular monthly amount if you cannot work because of illness or injury. It sits alongside life insurance and critical illness cover in the family of products often called protection insurance. This guide explains how the monthly benefit is worked out, how waiting periods affect when the money arrives and what to expect when you claim.

What Income Protection Insurance Actually Does

If an accident or long illness stopped you working, your salary would stop with it. Income protection is designed to replace part of that lost income, paying a monthly benefit while you recover, with the payments ending either when you go back to work or when the cover reaches its limit. Some people have more reason to consider it than others. You may, for example:

• run your own business, where time off work means the money stops completely
• work for an employer whose sick pay is thin or nonexistent
• support a family who count on your pay packet
• have no savings or second income to lean on

Policies can include practical extras as well as the core benefit. Some insurers add virtual GP appointments, mental health support, vocational rehabilitation to help you back to work, and Employee Assistance Programmes.

The wording that decides when a claim is valid differs from policy to policy, and so do the conditions attached to it. Two products with similar names can behave very differently, so the small print deserves a read before you buy, not after.

How the Monthly Benefit Is Worked Out

Cover is usually set as a percentage of your earnings. Policies commonly replace part of your pre-tax income, often somewhere between around 50 and 75 percent depending on the policy. Insurers usually look at what you earned in the year running up to the illness or injury and set the benefit from that figure.

How the payout is taxed depends on who pays for the policy. If you pay the premiums yourself out of taxed income, the benefit is generally paid tax-free. If your employer pays for a group policy and claims tax relief on the premiums, payouts are usually treated as taxable income and taxed through PAYE like a salary.

Deferred Periods: Waiting Before the Money Starts

The deferred period is how long you must be unable to work before payments begin. Common deferred periods are four, 13, 26 or 52 weeks, and some policies offer shorter waits or none at all. The longer the deferred period, the lower the premium, because the insurer is not paying for short absences. Most policies offer waiting periods anywhere between 14 days and two years.

A sensible deferred period often matches your employer’s sick pay. If your employer pays you in full for three months, a 13-week deferred period means the insurance starts just as the salary stops. With minimal or no employer sick pay, a shorter wait matters more, though it costs more each month.

A worked example, for illustration only. Say your policy pays 65 percent of your salary with a four-week deferred period, and you are signed off for six weeks after an operation. No benefit is paid for the first four weeks. You then receive 65 percent of your pay for the remaining two weeks, and payments stop when you go back to work. With an eight-week deferred period on the same policy, you would be back at your desk before any payment fell due.

Benefit Periods: How Long Payouts Can Last

The benefit period is how long the monthly payments carry on while you remain unable to work. Most policies offer two or five years, or longer, with the payments stopping once you go back to work or the period runs out. A longer benefit period costs more, because the insurer could be paying a claim for years rather than months. It is one of the biggest factors in the price, so think about how long you could manage from savings or other support before the cover would need to take over.

Why Your Job and Health Affect Cover and Cost

Insurers ask about your occupation, health and personal circumstances when you apply. The criteria can be strict, and some occupations are excluded from certain policies, so getting cover can be difficult or more expensive depending on what you do for a living. Age matters too, with cover generally costing more as you get older. The premium also reflects the level of cover you choose and the deferred period you set.

When comparing policies, look at the features side by side rather than the headline price alone. Our guide to using comparison sites without the pitfalls explains how to spot what a cheaper quote leaves out.

Be straightforward on the application. Omitting something significant can give the insurer grounds to adjust the terms, end the cover, or turn down a later claim.

Watch for: Some policies pay out only if you become severely disabled and cannot do any paid work, or only for permanent total disability. That gives much weaker protection than the name implies, so confirm exactly which type of policy you are getting before you buy.

How It Differs from Critical Illness Cover and Payment Protection

Critical illness cover pays a lump sum if you are diagnosed with one of the specific conditions listed in the policy. Income protection works differently. It pays a steady monthly income for as long as you cannot work, judged against how the policy words incapacity rather than against a fixed list of illnesses. The two do different jobs, and some people hold both.

Payment protection, sometimes sold as accident, sickness and unemployment cover, is typically short term and often includes redundancy. Long-term income protection usually covers illness and injury only, but the payments can continue for far longer, which is what makes it suitable for conditions that keep you off work for months or years.

What Happens When You Claim

You notify the insurer, provide evidence of your illness or injury, and wait out the deferred period. You need to still be off work when that waiting period ends for payments to start. Once a claim is accepted, the monthly benefit carries on while you remain unable to work, stopping when you go back or when the benefit period is used up. Tell the insurer if you start recovering part way through, as the policy terms will set out what happens then.

Claims can be refused, sometimes for reasons that only surface later, such as something missing from the original application. Our step-by-step guide to making an insurance claim explains what to expect, and our article on rejected claims sets out how to challenge a decision you believe is wrong.

Before buying, work out what other support you would have if your pay stopped: employer sick pay, state benefits, savings and anyone who depends on your pay. The space between those two figures is what the cover is there to fill. A practical first step is to draw up a budget of your monthly outgoings and the income you would need to replace, then speak to a financial adviser if the numbers are unclear.

Questions answered

How much of my salary does income protection pay?
Policies commonly cover around 50 to 75 percent of your pre-tax income, based on what you earned in the year before you became unable to work. The exact limit depends on the policy.

When do payments start after a claim?
After the deferred period, which commonly lasts four, 13, 26 or 52 weeks. You need to still be unable to work when the deferred period ends for payments to begin.

Do I pay tax on income protection payouts?
If you pay the premiums yourself, benefits are generally paid tax-free. If your employer funds a group policy and claims tax relief on the premiums, payouts are usually taxed as income through PAYE.

Can I claim if I can still work in another job?
Most policies pay out only if you cannot work in your main job and do not have a second job. If you can keep working in a secondary role, a claim on cover for your main job is usually ruled out, so check the policy wording.