Life insurance vs income protection insurance: what’s best for you?
Contents
- The difference between income protection and life insurance
- What is life insurance?
- The purpose of life insurance
- How life insurance works
- The main benefits of life insurance
- Who needs life insurance?
- What is income protection insurance?
- The purpose of income protection insurance
- How does income protection insurance work?
- The main benefits of income protection insurance
- Who needs income protection insurance?
- Can I have combined life and income protection insurance?
- Which one is right for you?
The difference between income protection and life insurance
Unless you’re living completely off the grid, you can’t avoid the cost of living. That’s why financial resilience is important: it gives us the ability to withstand downturns in our financial fortunes. The key to this is preparation and insurance is one of the best ways to be ready for unexpected money problems.
The name for this is protection insurance, which is different from the general insurance we have for our possessions, because it doesn’t protect tangible things: it looks after our spending power. Income protection insurance and life insurance are perfect examples, although designed for different aims – one protects you now and the other protects your family’s future.
What is life insurance?
Put simply, it’s a means of arranging a payout to your family and dependants that’s triggered if you pass away.
The purpose of life insurance
Life insurance is a contract between an individual and an insurance company under which the insurer promises to pay an agreed lump sum to the individual’s beneficiaries if they die while the contract – or policy – is active. The individual keeps their side of the contract by paying regular premiums and making sure they don’t do anything that contradicts the terms of the policy.
The purpose of life insurance is to provide financial help to the people who are left behind if the policyholder dies. It may be to help with routine daily expenses, to clear outstanding debts, to provide for large future costs or a mixture of all three.
How life insurance works
There are two basic types of life policy: whole life and term life. A whole life policy has no fixed end date – it continues until the end of your life. A term life policy is of a fixed length, that could be 5, 10, 20, 30 years or longer. If you live longer than its end date the policy comes to an end and there will be no payout. Term life policies tend to be cheaper and are often chosen by people with more definite financial plans, such as paying off a mortgage or giving adult children a hand onto the property ladder.
The main benefits of life insurance
- Replaces your lost income that your family relies on
- Can pay off mortgages, loans and credit card debt
- Covers funeral expenses
- Pays for future costs such as university tuition fees
- Is usually tax-free
Who needs life insurance?
Anyone with a partner or family should consider life insurance but even single people might need it if they’re looking after elderly parents, siblings or other relatives. Joint life policies are available for spouses and life partners, ensuring that the survivor in a relationship is taken care of. Life insurance can also be useful in business to minimise the effect on a company or partnership of a partner or key employee dying unexpectedly.
What is income protection insurance?
It gives you the peace of mind and financial security of a regular income if you become too sick to earn your living.
The purpose of income protection insurance
Like life insurance, income protection is a contract with an insurer. You take out a policy which you pay for with monthly premiums. If you get ill or injured and have to stop working you make a claim and, if it’s approved, your insurer pays you an agreed proportion of your normal income in regular monthly payments.
How does income protection insurance work?
As with all insurance, income protection relies on planning. Once you’ve had to stop working it’s too late to get insurance cover. You take out a policy while you’re healthy and working then make a claim if you get ill or injured and have to stop. You’ll start receiving payments after a waiting period that’s fixed in your policy – anything from 1 week to several months, depending on what you’ve agreed. Your payments will continue until you can work again or you come to the end of your maximum payment period or your policy is cancelled.
The main benefits of income protection insurance
Depending on the level of cover and policy terms you choose, income protection can:
- Pay you up to 70% of your income, tax-free, which is only a slightly smaller percentage than the average take-home pay
- Cover all or most of your routine expenses
- Pay more than Statutory Sick Pay and Employment and Support Allowance
- Last longer than Statutory Sick Pay or occupational (employer) sick pay
You can also claim as often as you need to while your policy is active.
Who needs income protection insurance?
If you work for a living, whether employed, self-employed and even as a company director, income protection is worth considering. For most of us our income is one of our most important assets and without it we’d find it extremely difficult to maintain our lifestyles and keep up with our essential spending.
Can I have combined life and income protection insurance?
They’re entirely different forms of insurance and you won’t find an insurer that offers them in a single policy, although, if they provide both, they may be able to offer you a policy for each. These are the key differences between the two and also a few similarities:
As this table makes clear, life insurance and income protection are intended for different purposes but they are both designed to protect your and your family’s finances. It doesn’t have to be a choice of life insurance or income protection – the most effective long-term financial resilience lies in a combination of the two.
Which one is right for you?
Having said that a combination may be the ideal choice, some people may not feel able to afford both, even at the relatively low costs of some policies. If that’s the case then we’d suggest making a thorough assessment of your priorities.
Income protection insurance can help you through many periods of hardship when your loss of earnings and the inadequacy of statutory benefits would otherwise leave you highly vulnerable. If this feels like a more immediate concern that what might happen several years in the future then it could be the better choice.
Life insurance is protection for the long term and of course it won’t benefit you personally, but it can give reassurance and financial security for your loved ones. If you’re prepared to risk the shorter-term impact of temporary income less in order to pay for your family’s future support then you’ll probably go for life insurance.
Always bear in mind that the most comprehensive protection is provided by a combination of the two, giving you and your family a safety net not just for now but for many years to come.
Life insurance vs income protection FAQs
The premiums you’ll pay for life insurance and income protection are calculated according to similar factors including your age, health, medical history, occupation, leisure activities and the amount of cover you want. This is part of what’s called the underwriting process.
Life insurance payouts are generally not subject to tax, unless the policy is constructed in such a way that proceeds from the policy pass into the estate of the deceased and become liable to inheritance tax. This can be avoided by putting the policy in trust. Personal income protection policy payouts are tax-free, but if you’re covered by an employer’s group scheme you will probably pay tax.
Only in certain circumstances. As a rule, most insurers won’t ask you to undergo a medical exam unless they have specific concerns about your health. When you make a claim in your income protection insurance you may be asked to see a specialist nominated by the insurer if there is any uncertainty about the nature of your illness or injury.
If you can afford to pay for both it’s well worth considering as a combination of the two gives you and your family the most comprehensive financial security.
