With no sick pay entitlement or employer-provided sickness benefits, income protection insurance – which can protect from any unforeseen shortfall in income – is a very popular policy with freelancers, and rightly so.
This guide helps to set out what you need to consider when taking out this cover, and the types of policies available to you as a freelancer or contractor.
What is Income Protection Insurance?
The purpose of income protection is to replace a proportion of your lost earnings should to have to take a period of time out of work due to illness or injury. The policy would pay you a monthly income so you are able to keep up with all your essential monthly outgoings, such as your mortgage payments and food costs.
When you set up the plan you will need to select the maximum length of time that the policy could pay out for, with the options being for 12 months, 24 months, 60 months or even until your chosen retirement age, which means that the policy would pay you for as long as you need it to. If your budget allows, this last option is the ideal – especially as in 2012 the insurer Aviva published an average claim length of over 9 years on their income protection plan.
You will also need to decide how soon you would like to start receiving the payments after becoming incapacitated, which is called the deferred period. With no sick pay it is natural to select the shortest period of 4 weeks, but if you have savings and could survive for 13 weeks you could benefit from a premium reduction of around 40%.
Cover for Sole Traders
The fact that you are a sole trader doesn’t restrict your choice of policy or insurer in any way, but it is important not to over-insure yourself. It is usually only possible to cover up to 70% of your gross income (which would be paid tax-free) and many freelancers make the error of basing their level of cover on their revenue rather than their profit before tax, which is what insurers would require evidence of at claims stage.
Insurers won’t pay out a level of cover beyond their maximum percentage of income limit so be conservative with your gross income estimate, especially if your earnings fluctuate from year to year. Essentially, insurers want to make sure no one is better off out of work than in work as there would be no incentive to return to work.
Cover for Company Directors
If you are a freelancer and work through your own limited company then there is another type of policy available to you, which is called Executive Income Protection.
An Executive Income Protection policy is owned and paid for by your business. Although the final decision would come down to your local tax inspector it is usually the case that the premiums paid by the business are tax deductable, and therefore this is a popular method of taking out cover for a company director (please consult your accountant for specific tax advice).
It is, however, important to note that any payout from the policy would be treated as a trading receipt and would therefore be taxable. That is why it is possible to cover up to 80% of your salary and dividends with executive income protection, rather than the 50% to 70% with a personal plan.
Please note that Executive Income Protection is not currently quoted online anywhere, so you would need to consult an insurance advisor to gain pricing, which you may then like to compare to the premiums charged for a personal plan.
Don’t get confused with Payment Protection
When searching for income protection online you will come across a large number of different policies and unfortunately many of those plans will be payment protection insurance (PPI) rather than income protection. In this sense the name ‘income protection’ can be misleading as it can refer to either policy.
Despite the bank mis selling scandal there is nothing inherently wrong with payment protection (sometimes called accident, sickness and unemployment cover) – it is just a significantly inferior policy to traditional income protection.
The typical benefits of income protection over payment protection include the following:
- A fixed length of cover where the insurer cannot cancel your policy or increase your premiums
- A payout length of longer than 12 months
- Access to ‘own occupation’ cover where the policy will payout if you cannot do your specific job (some payment protection plans may assess your ability to undertake another role).
Photo by Kevin Steinhardt