How Much Income Protection Insurance Do You Need?

These plans work by paying you an income but they do not allow you to make a profit out of your misfortune. Therefore the maximum amount of income you can replace through Income Protection insurance is broadly the after-tax earnings you lost less any adjustment for any state benefits you claim.

Therefore it is important that you do not buy too much cover.

Read our article on the benefits of income protection insurance.

Typically, this is equivalent to 50 - 75% of your usual salary. Even if insurers accept a policy covering say 60% of your gross earnings, if on a claim, after taking tax into account, they find this would make you better off than when you were working they will reduce the amount of benefit paid out.

You may only want to cover basic costs, or just cover mortgage payments, but remember the more you insure for the higher the premium. Income Protection insurance was developed when most people got a simple weekly or monthly wage. With contract employees, bonuses, shift payments, overtime, benefits in kind, bonuses and dividend payments; therefore it is no longer simple to calculate the amount of benefit you should insure yourself for.

If you are self-employed then the benefits under the plan are calculated based on the amount of your taxable income, normally for the 12 months before you became unable to work.

You also need to consider the length of time you require the cover for. The benefit is generally paid until the termination date of the policy, which can be before your retirement age, depending on the policy's terms and conditions.

Alternatively you may want to buy a policy for a fixed period of time such as five or ten years however some insurers restrict the choice to say aged 50, 55, 60 and 65.

Many policies are flexible in a way that you can amend the policy if you find you are retiring later than planned.

As earnings and prices tend to rise over time by inflation, it is sensible to "index link" or otherwise increase your benefits so that they increase in line with inflation. Some insurers also allow you to increase the benefits either at annual review, or at any time during the lifetime of the policy. Others will only allow you to increase benefits if you can prove marriage, childbirth, salary or mortgage increase.

Having said all this it is vital to review your policy every year to ensure your cover has kept in line with your income and your financial commitments.