Managing the Financial Impost of Income Protection Insurance
Just like health insurance, the cost of income protection insurance increases as we get older. So does the risk of something happening that will require us to rely on it.
For many Australians, the cost of income protection insurance is a barrier to taking it out – it is estimated that only about one third of working Australians hold income protection insurance outside their superannuation. Leaving aside the fact that many Australians are not even aware of what income protection insurance is, or what it covers, you might be one of those who is weighing up the cost of insurance against the likelihood of something happening that will reduce your income earning capacity.
But there are ways to manage the cost and still provide yourself and your family with a fallback in case you are severely incapacitated by injury or illness.
First, though, let’s consider why you should make income protection a key part of your financial planning strategy:
- Your earning capacity between ages 25 and 60 is probably your most valuable asset – more than your house or your share portfolio. And it only gets more valuable as you get older and earn more money.
- Nearly one million Australians every year take extended time off work due to illness or injury.
- Your ability to save, invest, make mortgage repayments and cover day to day living expenses is severely restricted if you a seriously incapacitated for an extended period of time.
So you’ve established you need income protection, paying for it comes next. There are meaningful ways that we can reduce the cashflow impact of income protection insurance, while still retaining this vital piece of your financial security. These might include:
- Reducing the benefit amount, particularly if you have good savings or investments that can be relied on.
- Opting for a longer waiting period – for example 90 days instead of 30 or 60 days.
- Obtaining comprehensive cover through a split policy which is partly covered by your superannuation fund and partly covered by personal payments.
One important consideration that many people are unaware of is that the premiums for income protection cover held outside your superannuation fund are almost always tax deductible. The amount claimable will depend on your taxable income and marginal tax rate and will therefore vary for each individual. Nevertheless, this is a highly effective mechanism for reducing the cashflow impact of insurance premiums.
Before going down the tax deductibility path, it is important to understand the nature of your cover and its tax deductibility status. For example, coverage under your superannuation fund is already tax exempt and can’t be claimed. Similarly, term life, trauma and total and permanent disability (TPD) premiums cannot be claimed – they insure your person not your income.
It is also important to be aware that:
- you can only claim for premiums paid during the tax year.
- in the event that you receive income protection payments, you may have to pay tax on those.
The most important thing to do is to understand your personal circumstances, determine what type of cover you require and then consider the options for reducing the cost impacts of your income protection insurance cover by tailoring the cover to suit you.