Income protection insurance pays part of your lost income if you're unable to work because of a disability caused by illness or injury. It can help pay the bills so you can focus on getting better.

What income protection insurance covers

If you're unable to work due to partial or total disability, income protection insurance pays:

• up to 90% of your pre-tax income in the first six months, and
• up to 70% for a specified time after six months.

Income protection insurance is designed to replace your income based on your annual earnings in the 12 months prior to your illness or injury. 

Each income protection policy has its own definition of partial or total disability that must be met before a claim is made. Check the insurer's website or the product disclosure statement (PDS) for the definition and any exclusions.

Deciding if you need income protection insurance

Income protection insurance can be important if you:

• are self-employed or a small business owner, as you may not have sick or annual leave
• have family members or dependents that rely on the income you earn
• have debt, such as a mortgage, you'll need to make payments on even if you're unable to work

To work out how much income protection you need, prepare a budget. This will help you see your monthly expenses and the income you'll need to replace. You may want to factor in making payments to your super as well.

Also consider:

• if you have total or permanent disability or trauma insurance, that can help replace lost income
• if you have private health insurance that could help pay for any medical expenses
• what help or support from family or friends may be available

If you want help deciding if you need income protection insurance and how much, speak to a financial adviser.

Choosing an income protection policy

Some of the things you'll need to consider when choosing an income protection policy are:

Policy type

Income protection policies are either an:

• Indemnity value policy — the amount you're insured for is a percentage of your salary when you make a claim. If your salary has decreased since you bought the policy, you'll get a smaller monthly insurance payment. If your income is variable, your insured amount will be based on average annual earnings over a period of time appropriate for your occupation. 
• Agreed value policy — the amount you're insured for is a percentage of an agreed amount when you sign up for the policy. These are generally more expensive but can be useful if you have income that changes from year-to-year.

From 31 March 2020, insurers can no longer offer agreed value policies to new customers. If you purchased an agreed value policy before this date, you can continue to hold this policy. If you decide to change policies, you will only be able to purchase an indemnity value policy.

Indemnity value policies are generally cheaper and can be useful for people with a stable income. 

Waiting period

This is the amount of time you must wait before your payments start. Most income protection policies offer a waiting period between 14 days and two years. You must be unable to work as a result of your illness or injury at the end of the waiting period to be eligible for payments. 

In general, the longer the waiting period, the cheaper the policy. When you're choosing the waiting period, think about how much you have in sick and annual leave, savings and emergency funds.

Benefit period

The benefit period is how long the monthly payments will last if you remain unable to work due to your illness or injury. Most income protection policies offer two or five years, or up to a specific age (such as 65). The longer the benefit period, the more expensive the policy. But it also means greater protection if you're unable to work for a longer time.

Stepped or level premiums

You can generally choose to pay for income protection insurance with either:

• Stepped premiums — recalculated at each policy renewal, usually increasing each year based on the higher chance of a claim as you age
• Level premiums — charge a higher premium at the start of the policy, but changes to cost aren't based on your age so increases happen more slowly over time

Your choice of stepped or level premiums has a large impact on how much your premiums will cost now and in the future.

How to buy income protection insurance

Check if you already have income protection insurance through super. Most super funds offer default income protection insurance that's cheaper than buying it directly from an insurer. You can increase your level of cover through your super fund if you need to.

You can also buy income protection insurance from:

• an insurance broker
• a financial adviser
• an insurance company

Premiums you pay for income protection insurance held outside of super are generally tax deductible. Policies outside of super usually allow a higher amount of cover and have more features and benefits available.

What you need to tell your insurer

An insurer will ask you questions when you apply for or change your insurance. These questions may be about your:

• age
• job
• income (salary, wage, commissions)
• medical history
• lifestyle (for example, if you're a smoker)
• high risk sports or hobbies (such as skydiving)

If an insurer doesn't ask for your medical history, it may mean that the policy has more exclusions or narrower policy definitions.

The information you provide will help the insurer decide:

• if they should insure you
• how much your premiums will be
• terms and conditions for your policy

It is important that you answer the questions honestly. Providing misleading or incomplete answers could lead an insurer to cancel or vary your cover, or decline a claim you make.

Making a claim on income protection insurance

If you want to make a claim, see making a life insurance claim for information on what to do. Any payment received under an income protection policy must be included in your tax return.