1 March 2013

Hold onto your pay in sickness and in health

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The biggest financial asset for most people is not their family home, their superannuation or a car but the ability to earn an income. But

Hold onto your pay

while most Australians have car insurance, only 39 per cent have life insurance and even fewer – 23 per cent – have income protection. 1Insuring your salary will provide a monthly income if you are unable to work due to sickness or injury. In the past, policies typically paid 75 per cent of a salary for two years. These days, many products offer longer benefit periods up to age 65, with up to 75 per cent of your salary paid monthly (80 per cent of your salary if superannuation guarantee payments are covered).

 

A 35-year-old male on the average wage can expect to earn $2.5 million up to retirement age. 2 But if he suffers a prolonged illness or disability that prevents him from working, who will pay his mortgage and support his family?

 

The Federal Government provides a limited safety net in the form of the disability pension but this would not meet more than the most basic of living costs.  On such a pension, a permanently incapacitated 35-year-old would receive a total of just $700,000 until he retired compared with up to $2 million if he had bought income protection.

 

An adequate safety net

One way to work out how your family would cope with the loss of the main breadwinner’s income is to add up your cash savings and holiday and sick leave entitlements. It is estimated that 19 per cent of Australians could only manage to get by for a month and 11 per cent would not last a week! 3 Workers’ compensation insurance may come to the rescue if you are an employee and are injured at work, but it does not cover accidents or illnesses unrelated to your job. Plus, it is difficult to predict the amount you might receive even if you do succeed with a claim. Workers’ compensation is designed to provide weekly payments in lieu of wages or a lump sum to compensate for permanent impairment.

 

The exact payout amount depends on the state you live in and often involves a lengthy claims process or legal intervention. 4 To reserve your family’s way of life at a guaranteed level of income, it is crucial to have an income protection policy. Some superannuation funds offer this cover but the benefits can be limited. However, if you are short of cash, the premiums for an income protection policy can be paid through your super fund with the money in it.

 

Tax advantages

Income protection benefits are taxable, but premium payments for cover outside super are personally tax-deductible. Say you earn more than $80,000 and pay a tax rate of 37 per cent, you could save the equivalent of 37 per cent of your insurance premiums after claiming a deduction.  You can also reduce the cost of premiums in other ways. You can extend the waiting period before claims are paid, reduce benefits or reduce the maximum

period that benefits are payable. The cost of cover also depends on your age, gender, occupation, health and smoking status.

Income protection is purchased on either an agreed-value basis, where you set the benefit level when you take out the policy, or an indemnity basis, where the benefit is determined by your income in the lead up to your disability. Agreed value cover is rare among super funds, under regulation the amounts that a super fund can pay out to a client for a protection claim is aligned to an indemnity definition (income at the time of disability). However, it is the preferred option for everyone, especially when income may fluctuate.

If you are self-employed, run your own business, or are a professional who relies heavily on your ability to work, then failing to protect your income is a risk you can’t afford to take.

 

Martins’ story

Martin, 35, was a product manager at a major retail chain earning $65,000 a year. His wife, Melissa, had recently returned to work part time when their youngestchild started school. The couple had a mortgage of $300,000 and hoped to send their two daughters to a private secondary school. Then one day, their lives were turned upside down when Martin was thrown from his surfboard and injured his spine. He spent six weeks in hospital and was unable to return to work for nearly 12 months while he had intensive rehabilitation.

Luckily, Martin had taken out income protection insurance when Melissa gave up full-time work to care for their girls. Under his policy, Martin received 75 per cent of his pre-injury salary, or $4000 a month after a waiting period of 30 days. His insurer paid him $48,000 in one year and he could have continued receiving payments until age 65 if he was unable to work again.

 

1 Lifewise, 2012, viewed 10 December, 2012, http://www.lifewise.org.au/today-from-lifewise/areaustralians-risking-it-all/

2 Lifewise, 2012, viewed 10 December, 2012, http://www.lifewise.org.au/insurance-101/your-income-yourgreatest-asset

3 Lifewise, 2012, viewed 10 December, 2012, http://www.lifewise.org.au/today-from-lifewise/areaustralians-risking-it-all/

4 http://www.business.gov.au/BusinessTopics/Occupationalhealthandsafety/pages/Workerscompensationinyourstateorterritory.aspx

The author is an employee of Verante Financial Planning in Castle Hill, Corporate Authorised Representative of Magnitude Group Limited, Licence No 221557, Magnitude Group Limited ABN 54 086 266 202.

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