If I asked you whether you would insure your car, I suspect like the majority of people, you would respond ‘of course’! But ask someone whether they have insured their biggest asset, that is their income, you’ll often hear silence.
Most people think of their biggest asset as their house or car or perhaps their retirement fund, but your greatest asset is actually your ability to earn an income. Imagine you are no longer able to earn an income from today onwards. For most of us this would have a dramatic impact on our ability to achieve many of our financial & lifestyle goals.
For example, a 25-year old, who has something serious happen to them, whereby they are unable to work for the next forty years, the financial & lifestyle impact would be devastating. There’d be no ability to pay the rent or mortgage or to save for retirement. The potential loss of forty years of income could be millions of dollars when we allow for inflation and lost job promotion.
A Biblical Perspective
When it comes to planning for unexpected events the Bible offers some sound wisdom:
“A sensible man watches for problems ahead and prepares to meet them.
The simpleton never looks, and suffers the consequences”.
Nobody knows the future, but it is realistic to suggest that there are some common problems that anyone could face, from unexpected illness, job loss or even premature death. We hope these things never happen to us, but they are a risk that everyone faces. As a Christian we should apply the wise words from Proverbs of preparing to meet potential problems.
Dealing with Risk
How do you prepare for potential risks? You have four basic options:
Accept – accept the risk. This is referred to as self-insurance and basically means that you will manage the consequences if and when that risk is realised.
Avoid – avoid the risk. You actively avoid a risk altogether. If you believed that air travel was dangerous, you instead choose to take the train instead to avoid the risk completely.
Reduce – reduce the risk. You take steps to reduce the level of risk. You may still choose to drive your car, despite the risk, but instead ensure you obey all signs and road rules to reduce your risk of an accident.
Transfer – transfer the risk. This is insurance whereby you take a risk, such as the risk of damage to your car in the event of an accident, and transfer the financial risk to an insurance company.
Insurance is often accompanied by many myths and false perceptions. It is important to be clear the real purpose for insurance:
It is not to make you rich, but to prevent you from being poor
Provide for you & your family in the case of an unforeseen event
Cover living expenses & debts
Help you get back on track
Ultimately it is to prevent financial ruin.
Income Protection is an insurance policy that pays you an income stream in the event that you are unable to work. Generally (subject to provider) income protection will provide you with a monthly income of 75% of your gross income until you are able to return to work.
What are the main reasons for Income Protection:
- How many months could you go without income before you would default on your mortgage or rent?
- How would you family be impacted if your income stopped altogether?
- Do you have sufficient capital so that you can live without income?
- One of the good aspects is that income protection is that it is generally tax deductible (speak to your accountant)
How It Works
An income protection policy has the following features:
Monthly Benefit – this is the amount that is paid to you in the event you make a claim on the policy if you are unable to work. It generally pays 75% of your pre-tax income as a monthly income stream subject to the terms of the policy and that you satisfy the insurance company’s definition of disability (hence: unable to work).
Waiting Period – this the time that elapses from when you make a claim until when you receive your first payment. You can elect a waiting period from 14 days to 2 years. You should select a waiting period based on how many months you can afford to be without an income due to your savings. Note the comment below on ‘arrears’.
Benefit Period – this the time when you are receiving the monthly benefit from when the waiting period has subsided. The benefit period can be as little as 2 years up until age 65 (varies between insurance companies). As a general rule I suggest as long a benefit period as available to ensure that you have sufficient funds in the event of a catastrophic life event.
Premiums – these are the payments that represent the cost of the insurance policy and are paid to the insurance company. In some countries these premiums will be tax deductible.
Arrears – most insurance companies pay the monthly benefit in arrears. In other words if you have an insurance policy with a 1 month waiting period, it will be 2 months before you receive your first payment. The first month is the waiting period, and then the insurance company pays at the end of the next month.
The name “income protection’ will vary from country to country. In the US it is referred to as “Disability Insurance”. In Australia there is a slight variant called “Salary Continuance” that relates to short-term income protection policies.
Hopefully you will never need it, but the statistics show that roughly 1 in 3 people will be off work due to sickness or disability for more than 3 months before they reach they retirement age. This makes income protection well worth considering.
To learn more about insurance and protecting your family check out our Wealth with Purpose course here.