Conal Gregory: Double risk of pratfalls no laughing matter

Published on Friday 4 June 2010 21:52

PROTECTING not only your lifestyle but also those closest to you should be a priority. Yet advisers report that currently 80 per cent of the workforce has no income protection cover.

If you are unable to work, your life will change substantially. With no income, you will not be able to save, pay a mortgage, contribute to a pension – or enjoy some of life's luxuries.

A person aged 25 who earns 25,000 annually and plans to retire at 65 will earn about 1 million during their working life, excluding pay increases, bonuses and promotions. So why would you not insure an asset potentially worth 1m or more?

Few people realise just how insignificant government help is if they are off work through ill health or disability. Income protection should be the cornerstone of all financial planning, whether employed or self-employed.

Many professionals including teachers and public service staff think that up to six months' full pay followed by another six months on half-pay would be enough, but they fail to consider what would happen in the event of long term absence from work.

"Pension schemes are highly reluctant to pay ill-health benefits when a member is forced to leave employment owing to health issues," warns Iain Wishart, both a chartered and certified financial planner at Edinburgh-based Wishart Wealth Management.

He only recommends income protection plans that offer guaranteed, non- reviewable premiums. Otherwise the insurance provider can escalate the cost. Wishart also stipulates that benefits are payable if you cannot perform your own occupation – as opposed to any occupation – which is a crucial distinction.

Income protection can provide tens of thousands of pounds of tax-free cover through to the normal retirement age. Some insurers now permit protection right through to age 70, up from 65.

Company directors can insure up to 75 per cent of earnings including dividends, national insurance payments and pension contributions and have their company pay for the premiums.

It pays to consult an independent financial adviser who will research the market. And, as Alistair Blyth, chartered financial planner at AB1 Financial Planning notes, an IFA will often have access to specialist providers who are not on search comparison websites.

Go for guaranteed rates throughout the lifetime of a contract. If it is reviewable, rather like car insurance, a provider who has a bad experience can suddenly increase the rates.

"I am a firm believer that everyone should have both income protection and life assurance protection as it is vital to protect an income stream against being sick or hurt, as well as the lifetime economic value of a client should they die prematurely," says Max Horne of Dunfermline-based Max Horne Group.

"Look carefully at a provider's definition of disability," tips Michael Stokes of Michael Stokes Financial Planning. Expect some medical exclusions, but it is still better to have 90-95 per cent of risks covered and make provision through an emergency fund for the balance.

Horne adds: "When using life cover to create an income, it is prudent- double up the cover you would have had three or four years ago, as the income the lump sum can generate assumed a return of 5 per cent, whereas now, you are lucky to get half that, by depositing money in a high street, no-risk, bank or building society account."

One way to overcome this problem is to set up a family income benefit contract which guarantees to pay out each year as income, says Horne. "This is perhaps the cheapest form of cover that an individual can take," he adds.

Married people should take out two individual policies. The ideal combination would be to have income protection insurance for the basics of life with a lump sum critical illness cover on top to cater for one-off expenses, like perhaps having to adapt a house or paying privately for a life-saving operation.

Consider also some family income benefit insurance to provide an ongoing income on death and then a lump sum life assurance policy to pay off all debts and to replace the future income of the individual on an indexed basis.

For individual income protection, Wishart likes Aegon, Aviva, Bright Grey, Friends Provident, Legal & General, LV> (formerly Liverpool Victoria) and Scottish Provident. All offer "own occupation" contracts with guaranteed premiums.

The choice of provider will depend not only on the premium but on the level of cover required, the occupation, and its history of settling claims. A good IFA will keep an eye on claims paid and the number of and reason for rejections.

Edinburgh-based Stokes recommends Friends Provident for both its good cover and administration. There are two types of protection plan to avoid: those that purport to offer an investment return or have reviewable premiums which can rise every five years.

Few hoping to rely on government help realise that there are now more rigorous qualifying criteria adopted by the Employment and Support Allowance, placing the emphasis on what an individual can do rather than on what they cannot, and generally paying no more than 95 a week. Early indications are that only 16 per cent of applications are successful, compared with 83 per cent under former incapacity benefit rules. Yet do not be put off by the possible price. In a survey by Moneyfacts, 31 out of 36 premiums are lower now than five years ago. For example, Scottish Provident repriced its range in late January which resulted in some rates falling by almost 30 per cent.

Take out income protection before critical illness cover although, ideally, both should be in place. If the latter alone was purchased, you would be unable to earn a living if you suffered from a bad back. But you could not claim under a critical illness policy unless the problem was permanent. If, instead, income protection had been bought, you would be covered until you returned to work.

Several factors affect an income protection premium. Ladder-climbing painters and decorators can expect to pay significantly more than an office bound administration clerk. Lifestyle choices will also have a bearing, with smokers and those enjoying hazardous sporting hobbies paying higher premiums.

Discuss with your IFA how long you could afford to live on your savings before income protection money would be needed. If you can defer receiving payment from 13 to 26 weeks or even a year, premiums will reduce significantly.

Go for a policy with the fewest exclusions and limitations. Also, consider a provider who will permit flexibility in the event of a job change.

For the wider issue of life cover, only 62 per cent have any such protection. An amazing 4.2 million people have no life cover on their mortgage. Yet to ignore this could be to saddle one's partner with a substantial debt that they may have difficulty repaying.