Why is Income Protection for Contractors Important
As a rule, permanent employees enjoy three months sick pay if they can’t work due to illness or injury. Contractors don't get this benefit if they don't take out income protection. They otherwise expose themselves to financial hardship from the first day they can't work.Being self-employed is great when you’re earning. But if you can’t make it to site or are unfit for work in any way, where’s your income going to come from?
Don’t panic. There are ways you can protect yourself from financial disaster if you’re sidelined. But you need to be sensible about it.
Your income protection insurance should do just that: protect your contract income. What you need to decide is:
- how much income you should protect;
- what type is suitable for your circumstances;
- and for how long you need cover, both income protection and life insurance.
From our experience, no two contractors businesses and/or lifestyles are the same. What's right for you may not be right for the next person.
Protecting your livelihood has its roots in personal circumstances, personal choice. What we hope to do here is lay out the facts to help you reach an informed decision. We'll begin with PHI.
Permanent Health Insurance (PHI)
How much recompense do you want your insurance to pay out while you’re unable to earn yourself? Think about it. You may not need to cover your entire income.
Some costs you'll lose, like travelling costs or office rental. But you will incur other expenditure. Some expenses are obvious, others not so.
The least you’d need to achieve from income protection is to uphold your standard of living. But that's not as black and white as it sounds.
The circumstances when you’re off work ill aren’t the same as when you’re clocking in every day.
You’re spending money at home that you’d otherwise not be, especially in winter. If you’re ill during winter, you have to heat your home and entertain yourself indoors all day long.
Your nominal monthly Permanent Health Insurance premiums should support you during your entire convalescence.
There are policies that can encompass that need. They can even cover you if you’re diagnosed with an illness that lasts your working lifetime.
You don’t have to choose to cover yourself for life. How long you want cover for is down to how you view the risk of such circumstances happening to you.
That said, there’s still an air of mystery, even scepticism, surrounding Health Insurance. We aim to clear the fog by answering the questions you should be asking your insurance provider.
From there, you can use the questions as a checklist to see how your current cover stacks up. This is advisable, even if for now you’re only walking through the exercise.
Peace of mind is a great way of avoiding stress-related illness in the first place, right?
Who should pay health insurance premiums, my company or me?
You have the choice whether to pay for the cover in person or run the policy through your limited company. Either way you pay tax. It’s just a choice of whether you pay up front or only when you claim on the policy.
If you pay the premiums 'in person' from your net income, you’ve already paid tax. That's because the tax comes out as soon as you draw your salary.
The upside of paying tax up front is that the payouts you receive when needed are then tax free.
You can also choose to pay the premiums from your company account. Your accountant will deduct those premiums before tax. This works as a great incentive for contractors looking to save on their tax bill.
There is a downside, though. By paying your PHI premiums through the company, the benefit (payouts) become taxable income.
There’s no right or wrong way. Before you decide:
- weigh up the risk of likelihood of injury or illness in your profession;
- think about the tax you’d expect to pay should you claim, based on that deduction;
- then, work out how much tax you’d have already paid if funding the policy from your personal account.
No one can predict the future. Much of your decision you'll base upon your attitude to risk.
You pay premiums from your drawn salary, you pay tax up front, but pay none on payment of benefit. You put premiums through your company, you pay tax on the benefit.
If you're protecting a considerable amount of your income, you may be best paying tax up front. If you're covering the bare minimum, it may serve you to pay premiums through your company.
How long should I set the waiting period before I can receive payouts?
You get to set the ‘deferred period’ on your policy. That's the time between the date you’re first off work and when you receive your first payment. How long you choose to set that period will depend on your circumstances.
Deferred period, new contractors
If you’re new to contracting and have few savings to draw upon, it’s advisable to set a short waiting period.
Premiums for deferred periods get more expensive the shorter the time frame you choose. But it's worth biting that bullet when you first set out as a contractor. That's because you won't expose yourself to financial risk if you can’t work for even a short space of time.
Imagine that you have less than a month’s savings put by. In that case, you’d set the deferred period to the smallest insurance companies allow. That's 4-weeks. This means you’d have to wait only one month before you start to receive your benefits.
In effect, the payouts (benefit) will act like a monthly salary from the outset. That's how it helps reduce your exposure to financial risk.
If your disposable funds are minimal, begin with the shortest deferred period PHI offers. You can always extend that period later on. This will reduce the cost of premiums once you’ve built up a more stable financial footing.
Deferred period, experienced contractors
But what if you’d managed to accrue savings? Imagine now that you could afford to live off those savings for a few months before your first payout.
There's both an up and downside for choosing a longer deferred period.
On the downside, it would disqualify you from claiming if you were off work for two or three weeks. In that scenario, you'd live off what you've already put by.
But a longer deferred period will cost you less in the long term. What if your illness is serious? Your time off work may well encroach upon that longer deferred period.
The premiums you pay will be cheaper if you wait longer for your first payout. But you must be comfortable enough to wait for the benefit to kick in.
What you have to weigh up is this. Does your savings mechanism penalise you for withdrawals? And does that cost outweigh the benefits of your permanent health insurance policy?
If you have an ISA, for example. You may lose more in tax-free interest than you’d save by stretching out the deferred period.
If so, you’d be better off paying a little more for your Personal Health Insurance and claiming from day one.
What percentage of my income should I protect?
Personal circumstances have direct impact upon how much income contractors should protect with PHI. Your priority debts are the least your benefit should cover, expenditure like:
- mortgage repayments;
- secured loans;
- council tax;
- utility bills, your electric, gas and water.
From your disposable income, there’ll be expenditure you could reduce or strike out altogether. Dining out, socialising and work-related travel expenses should diminish, if not disappear.
But do include for journeys to and from any therapy. Unless your illness keeps you in hospital, it's likely you'll need to attend appointments. Few therapists will come to you.
Also factor in possible expenditure for commodities that will make your convalescence more comfortable. Home comforts you take for granted in good health will develop far greater significance.
Being at home 24-7 is a daunting prospect for contractors used to the commute every day. Even if it’s upgrading your TV/broadband or magazine subscriptions, work those figures in.
In extreme cases, you may even need special equipment to get around your home. This could mean making adjustments to your living quarters just to get around. Speedy recuperation associates itself with your comfort factor during ill health.
Your financial comfort (or lack thereof) will impact your recovery time. You’ll have much more time to dwell on the lack of it if your budget is tight.
This, in turn, also has a detrimental effect on speeding up your return to work. Not having adequate cover can become a vicious, unforgiving downward spiral in double-quick time.
What will my insurance company pay out on?
It’s imperative that your insurer or independent financial adviser understands the way you work. Some, if not most, insurers will only pay out on salary.
Don't forget: you're a limited company contractor. It’s likely that your ‘salary’ represents only a small percentage of your income. You’re much more likely to be drawing dividends in lieu of salary.
It’s imperative that your PHI policy encompasses dividends and bonuses, too!
Dividends are often interpreted as investment income, which many income protection policies won't cover. Dividends may be common in contracting circles, but standard income protection panders to permanent employees.
But there are providers who cover your income no matter how you pay yourself. You need to ensure you take out cover with one such provider.
Even then, double-check that they're aware of your limited company status. Otherwise you’ll be paying premiums, but won’t be able to claim enough to tide you over when you need it most.
Is the insurer a brand I can trust?
We’ve all heard horror stories about claimants receiving short shrift from their insurers. Before you take out a policy, do a little research. Check that there are no adverse reports online about your potential provider.
Typical tactics include delaying payments or even avoiding paying out on claims altogether. One criterion we judge our providers on is their ability to pay on time, every time.
Another is if you don't include any pre-existing conditions. If you have an illness or disease when you apply, be sure to say so. The cover provider may waive that condition. It may even affect your premium. But don't risk your payout by not being up front about it.
But if you're going direct, check out the company’s testimonials. Go to both their website and financial advice or watchdog websites, too.
Contractor cover isn't the same as your run-of-the-mill insurance
Research is worth doing, especially if the agent isn’t one you’ve heard of before. Remember, you’re looking for niche insurance cover. Expect the most suitable contractor income protection cover to be from an unknown agent.
As an alternative, you can choose to source cover through an IFA. They’ll give you honest feedback about the insurer they determine best suits your circumstances.
Even then, don’t be afraid to check out the firm online before committing to a plan. Your health and protecting your livelihood whilst you’re unable to work are not areas to skimp on.
There’s much more to choosing an insurer than cost alone. It’s much more prudent to find a provider that suits your needs than try to save the odd pound here or there.
Will my benefit reduce with inflation?
The world we live in is in constant ebb and flow. One thing we can guarantee is that inflation will flux, sometimes even going backwards.
So do consider reviewing your benefit cover every year. This is especially pertinent if you plan to contract for the foreseeable future. Make sure that your payout doesn't diminish because of the effect of inflation.
This may affect the premium you pay for cover. But as we alluded above, PHI is all about protecting your standard of living.
If that seems like too much trouble, there is a workaround. You can instigate an automatic increase in your premium on an annual basis. This increase in your premium can best guess what the rises in the cost of living will be each year.
Increasing by a set 2.5%, 5% or as per the retail price index reflecting inflation is common practice.
It’s important to get this figure, or cost indexation, right. You don’t want to end up paying over the odds. But neither do you want your cover to deplete in real terms to the detriment of your standard of living.
Beware: an insurer can insist you carry out another job
There is a way insurers can at least stall on paying out to those on long-term sickness. It’s not common, but this tactic is something you should at least know exists.
Your cover provider could agree that you're not fit to undertake your contract work. But they could argue that you’re fit to carry out other tasks.
You’re a skilled professional. Your policy needs to reflect your experience and ability.
If you want to return to work, it’s to the field in which you’ve built up your reputation and income power.
Make sure you take out 'contractor' income protection and for 'own occupation'
This is another key aspect of the insurer/IFA understanding your role as a contractor. You must insist upon your cover stating that any return to work is to the role it states on your contract.
The technical term will be “Own Occupation” income protection. This is what you want.
“Any Occupation” is likely to be of little use to you. Such cover gives the insurer an angle to refuse payment if you won’t accept other work.
Let's say you're a skilled surveyor who’s suffered a leg injury, forcing you to use a wheelchair. Accessing a site will remain out of bounds whilst you’re incapacitated thus.
Yet there may be a local company for whom your insurer deems you’re capable of working. The firm could offer wheelchair access and provide you with income, albeit for a menial job.
This could see you packing boxes, answering calls or carrying out light office duties. If you refuse to accept that role, they can refuse to pay you.
Contractors often overlook this aspect, so do clarify Own Occupation. Otherwise you could find yourself in unfamiliar territory sooner than you think. Moreover, it could impair your convalescence. Rather than get you back earning what you need, it could make a swift return to contract work less likely.
How long will my cover period last until?
You must always consider that a serious injury may mean you could never work again. Yes, it's a depressing thought. But it is a reality; as such, it’s imperative that your policy will cover you until your set retirement age.
If you’d planned on retiring at 55, ensure your policy covers you until then. And if you’ve set no date to retire yet? Be mindful that, for most contractors, pension age will not be until you’re 68 years old.
Yes, if your cover falls short of your retirement date, you may well be able to start claiming your pension. But this could see you penalised for withdrawing payments early.
Protect your now and your future. With bespoke contractor health insurance, your cover is for life.
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.