If you are an employee of any organization and you fall sick, your employer might pay you your full pay for a few weeks or months. By law, an employer must pay most employees statutory sick pay for up to 28 weeks, though this will probably be a lot less than your full earnings. After that, you would probably have to rely on state benefits.
However, some employers arrange group income protection insurance for their employees as an add-on perk of their job, which can pay out an income after the statutory sickness period. So check with your employer if you are entitled to get any such benefit as a part of your employment contract.
If you are self-employed, you won't have this option at all, and you’ll have to look for your own arrangements for insurance.
State benefits are not generous. You would probably see a substantial drop in your income if you were out of work for more than a few months because of illness or disability.
Insurance aims to put you back to the position you were in before you suffered a loss. But it does not allow you to make a profit out of your misfortune. So the maximum amount of income you can replace through insurance is broadly the after-tax earnings you have lost less an adjustment for State benefits you can claim. This usually translates into a maximum of, say 50% to 65% of your before-tax earnings.
Protection insurance
If you can't work because of illness or disability, income protection insurance (also called permanent health insurance) pays out a tax-free income.
Example of working out how much cover you need:
Nick is single and earns £26,000 a year before tax and other deductions. She estimates that, if she was ill for a long time, her budget would be affected as shown in the table below.
| Nick's budget calculations in the event that she couldn't work | Her estimates |
| Income she would lose her take-home pay | £18,000 |
| Deduct income she would gain approximate long-term incapacity benefit | £4,000 |
| Deduct expenses Nick would save work-related costs, mortgage interest payments if covered by mortgage payment protection insurance | £3,000 |
| Add extra expenses she would pay allowance for, say, cost of special equipment or treatment, cost of heating her home for more time | £2,000 |
| EXTRA INCOME NEEDED | £13,000 |
Nick reckons she would need around £13,000 a year to maintain her lifestyle. This is half her before-tax pay of £26,000.
Nick also works out that as a perk of her job, her employer will pay her half a salary for 52 weeks after the statutory sick pay period of 28 weeks. She therefore arranges for her policy to pay out after 80 weeks of incapacity.
More details on how protection insurance works will be covered in the next article.
Link to previous article Pension Term Assurance (PTA) – Part II
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