Income protection for contractors isn’t a luxury, it’s essential!
Last Updated: 12-11-2020
Reading Time: 12 minutes
So many contractors and freelancers overlook Income Protection it's frightening. Yet it can provide a tax-free monthly income to uphold your current lifestyle if you're unable to work due to illness or injury.
There are two reasons that independent professionals don't, but should, cover themselves. First, there's a short answer; then, a long one.
Here's the short version of why it's imperative all self-employed people have income protection.
Cover yourself: the short version:
Most people who venture down the self-employed route have worked as an employee before going it alone.
Their employer would pay a certain amount of sick leave. After that, as an employee, the DWP would pick up (some of) the tab.
It's different for contractors. For one, they're their own employer. If they're not earning, how can they pay themselves? If they can't pay themselves, how do they expect to uphold the lifestyle they've crafted for themselves?
And two, try convincing your local benefits office that, as a freelancer, you're unable to work because you're ill. It ain't gonna happen.
Why Contractor Income Protection is a Necessity (the long answer)
As a contractor, your income is dependent on your ability to turn up at your client’s site every morning. You don’t have any safety net to fall back on like permies, who enjoy “sick pay” benefits if they're unfit for work.
So what can you do instead? Contractors can get Permanent Health Insurance (PHI), which can pay out from the first day you're off sick.
Contractor Income Protection Insurance (CPHI) may, at first glance, appear similar. But do check the small print when you get your quote. PHI and CPHI are very different beasts.
It's all about getting the right level of cover and not just accepting the cheapest policy quoted.
How do I know this is the right policy for me?
There are a couple of factors contractors should note before taking out income protection. Protecting your livelihood is a choice you can't afford to get wrong.
Most of the standard cover available through recognised agents pay out solely on salary. This isn't suited to your income as a contractor, which you could draw using various methods.
It's essential that you find an insurance provider who understands your unique circumstances. Every contractor business is different. Make sure they offer a policy tailored to suit your trading status and lifestyle.
How much should cover cost?
Policies can vary in price depending on the extent of the cover and provider; always read the small print for the exclusions.
One thing you can't let guide you is the cost of the premiums. That should never be the deciding factor when choosing a policy.
A cheap policy may only pay out if you are deemed to be too ill to do any job, not just that on your contract. Or you may only be able to make a claim as a result of severe illness.
Neither circumstance may be adequate protection for the majority of business professionals.
One other word of note. Always check out the insurer. The best contractor-specific income protection may not be with a household name. You are a niche sector, after all.
Do check that the eventual insurer has an impeccable claims record of meeting obligations to clients. Testimonials are a great way of vetting potential agents.
Don't just check out the site. Check on the contractor and freelancer forums. See what your peers have to say or even whom they recommend.
Dividends and salary
For tax reasons, many contractors working through a limited company will draw a low salary. They'll derive the rest of their income in dividend payments to save paying higher-rate tax.
Yet some insurers exclude dividends. These are often deemed "investment income" so check that the policy includes such remuneration.
It's important not to fall into this trap, otherwise you'll end up paying premiums for cover you cannot claim.
‘Own’ not ‘Any’ Occupation
Contractors must source a policy that provides cover on an “Own” (not the cheaper “Any”) occupation basis.
“Own” occupation cover protects against illnesses that stop you from doing what it says on your contract. Recovering to get back to what you love doing is one thing. The possibility of having to something different could prolong your 'real' recovery.
And that's what “Any” occupation cover means. Despite your skill level and current income, an insurer could argue that you're able to return to work in some way. This could be in a supermarket, stacking shelves or in a postroom. If you've not taken out “Own” occupation, they will stop your claim.
This important clause is often overlooked and can mean that your cheap quote ends up costing you more than a few bob.
Keeping costs to a minimum
There are Income Protection plans that pay out benefits on the very first day of any illness. The most effective way of reducing costs to a minimum, however, is to accept a waiting period before you begin to receive a pay-out.
We call this chosen delay in benefit the “deferment period”; the longer you wait, the lower the cost. You should consider this option if you have savings that you can to fall back on.
Options for the deferment period of the policy are one, two, three, six and twelve months.
How long should I take out cover for?
The length of cover you choose depends on a combination of factors. These could be your personal and financial situation, your current life style and expectations.
It's prudent to guard against the impact of an injury or critical illness that would prevent you from returning to work ever. That may sound dramatic, but it happens. And all too often.
Just imagine if you could never work in your specialist area again and were stuck with a lifetime of benefits.
It's a harsh reality that too many overlook. A policy that will cover you into retirement could be the best investment you ever make.
Protection against inflation increases
You can also inflation-proof any benefit you'd receive from an injury or illness claim. If you succumb to a lifetime condition, again, this is priceless cover.
True, it's cheaper to select Level term cover. Level term means that any benefit received from your claim will remain at a fixed rate for life.
But if your illness stretched over a long period, inflation would erode the value of your benefits. The amount you receive at the outset would be worth a lot less in later years, assuming it wouldn't keep pace with inflation.
That's where the ability to inflation-proof your policy comes into a league of its own. By implementing this strategy, your benefit increases at the rate of inflation. In real terms, you'll have the same monthly spending power for the life of your policy. Now that's making your money work for you!
Should I select guaranteed or reviewable premiums?
The terms "Guaranteed" or "Reviewable" relate to the cost of the premiums you pay for a policy.
If you select the Guaranteed option, your monthly premium will not increase. That is, unless you choose to increase the amount of cover that you have, and the Insurer guarantees that it won’t increase.
It is worth checking yourself the level of cover, from time to time. Our circumstances change, thus, we should expect our income protection to adapt in accordance.
If you select the Reviewable option, the Insurer can increase the premium you pay at their discretion. But they can decrease it, too.
There are factors that can effect how much your pay and how often your provider reviews your income protection premium. These could be changes in the insurance market or advances in medicine.
Most insurers set a defined period for the first review, then repeat the review on similar anniversaries. If the difference in cover/premium is negligible, they may not make changes.
If you trust yourself to review you circumstance with an unbiased eye, then the Guaranteed option may be best for you. If you need a prompt, then Reviewable's the way to go.
Who pays the premium, me or my company?
You have the choice of how you pay for your policy. I know. Another decision to take into account. To be fair, I didn't say choosing was gonna be easy, did I?
Anyway, you can pay for Personal health Insurance cover from your personal net income after tax. This is Personal Cover, in which case any benefits paid from the policy would be tax free.
Alternatively, you can apply for Executive Cover. In this instance, you'd pay the premiums through your limited company account.
If you choose Executive cover, benefits would enter the company tax free. But when you draw any of that benefit as income, you'd then pay tax and national insurance.
Through the Executive Cover, you can insure up to the value of 75% of income. The premium payment, although you can class it as a business expense, is not a "payment in kind" benefit.
Don't forget who you're doing this for
As with the vast majority of insurance policies, the exact premium you pay will depend on a combination of aspects:
- your age;
- women pay more for income protection policies than men!?
- current health and lifestyle choices;
- do you smoke, drink more than the recommended guidelines, partake in recreational drugs, etc.? You know the score?
However, unlike other policies, your occupation will have a significant bearing on the cost of cover. For instance, the number of claims for back problems is significant compared to other injuries. So, those in more physical jobs, such as building work, will pay more.
It may be a bitter pill to swallow, but it's crucial you select cover that, you know, protects you when you need it!
As a contractor, your entire livelihood could rest on the support income protection provides. You never forget business, van/car or home insurance. You always put your family first. But what about your most important asset? You!
Our in-depth guide has covered many of the questions our clients raise. It's also covered many aspects that contractors tend to sweep under the carpet when it comes to income protection. Don't let illness or injury pull that rug from underneath you!
John Yerou is a pioneer of contractor mortgages and owner and founder of Freelancer Financials, Contractor Mortgages®, C&F Mortgages and Self Employed Mortgages, trading styles and brands of the award-winning Mortgage Quest Ltd.
Posted by John Yerou
on November 30th, 2009 15:42pm in