How does income protection insurance work in the UK?

Full answer

Income protection insurance replaces a portion of your earnings if you are unable to work because of illness or injury. Policies typically pay between 50% and 70% of your gross income, and payments can last until you recover, until the policy term ends, or until you reach retirement age -- unlike short-term income protection, which pays for a limited period such as 1 or 2 years. There is a deferred period, also called a waiting period, before payments begin -- commonly 4, 8, 13 or 26 weeks. Choosing a longer deferred period reduces the premium because it assumes you can cover yourself from savings or sick pay for longer. The deferred period should align with how long your employer pays sick pay, or how long you could live on savings. If you pay the premiums yourself, from post-tax income, the monthly benefit you receive is generally paid free of Income Tax and National Insurance. This is because you paid the premiums from taxed income, so HMRC does not tax the payout again. If your employer pays the premiums as an employee benefit, the position is different: the premiums may escape Income Tax and NI when paid, but the benefit you receive when you claim is taxable as employment income through PAYE. Employer-paid policies are known as group income protection schemes. Own-occupation policies pay if you cannot do your specific job; any-occupation policies pay only if you cannot do any work at all, which sets a much higher bar for a claim. Own-occupation is generally more generous and more expensive. Use a budget planner to work out how much monthly income you would need if you were off work, and then compare that against your emergency fund and sick pay entitlement to decide how large a benefit you need.

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