Our friend has recently suffered a serious illness and can no longer work. He said we should look at income protection insurance. What is that and how does it work?
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Why is protecting our income such a big deal? Well most of us are working for the day when we can stop working. We need income from our jobs so we can invest and build assets so one day these assets can pay us an income. Let’s call this Plan A. Put simply income protection is a tool successful people put in place to secure their future and retire with dignity. If we’re serious about our plan A and we value it, we insure it, right? What’s the common theme with all plans? They often don’t go exactly to plan. It makes sense to have a Plan B for every Plan A. Having said all this if you don’t have any plans for the future, you’ll hardly appreciate insurance - your plan B and you’ll never value it. You’ll always see it a cost.
Income protection is the cornerstone of any well thought out personal plan. It is essentially an insurance to protect your most valuable asset – you and your ability to work and fund your plans. It pays you a monthly amount should you become ill or have an accident and be unable to work, replacing the wages you would have been receiving if you were at work. Everyone who earns an income, should protect it. Would you protect a golden box in your garage printing money? I would. Well, that golden box is you and its real valuable.
It also important to point out Income Protection is only one way to protect yourself from potential disaster. It purely relies on your inability to work. If you’re diagnosed with a serious illness but still can work (due to early diagnosis for example) this cover may not pay at all. It’s why it has to be complimented with other types of protection that pay a claim on diagnosis of a particular condition rather than when you’re off work. It’s an important detail. It means that regardless of how serious your medical condition is, if you’re able to go to work this cover may not pay the claim. I’m mentioning this because the majority of negative noise we hear about insurance comes from people not understanding the cover they hold and assuming they’re covered for something they’re not.
It’s also absolutely crucial you recognise the difference between the easy cover you can obtain without your health being assessed. This process is known as underwriting. This can often be seen as onerous and painful when you’re applying for cover. It’s for a good reason though. Think about it, if you were an insurer, would you want to know about my background and medical history prior to insuring me? Or would you just take on anyone over the phone? It can make all the difference between actually paying your claim out one day, or not. Generally speaking, the more difficult it is to get the cover the easier it gets at claim time. And that’s when it counts most when it comes to any insurance.
The other key decision to make is how you want to own this policy. You could buy this cover personally and fund it from your bank account or you could opt for your super fund to own it. It’s important to note whoever pays the premium claims the tax deduction as income protection premiums are tax deductible. Most super funds will offer some sort of income protection policy. The features may be limited however if we have competing cashflow goals, super ownership might be the best option.
If you’re hopes and dreams are to one day be living your life on your terms or as we financial planners like to say “achieving financial independence” then income protection is the foundation first laid to which we build your wealth accumulation strategy on. But don’t forget to seek advice around your Plan A first, or your Plan B will be without a purpose.
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