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October 04 newsletter

What is income protection insurance and do we need it?

Income protection insurance provides an income stream in the event that illness leaves you unable to work.

In New Zealand, if you are incapacitated through accident, you are protected by the ACC. "The accident compensation scheme generally covers you for treatment of personal injury. A 'personal injury' is a physical injury or a mental injury caused by a physical one."

But, the ACC expressly does not provide cover against illness.

Each year, thousands of ordinary New Zealanders under retirement age suffer debilitating heart attacks, strokes and various forms of cancer.

For most, their income earning potential is their greatest asset. A salary of $70,000 will provide an after-tax income of approximately $50,000. Over 40 years, that amounts to two million dollars. A major period of disablement could seriously dent your financial plans.

Add to that the emotional and physical pain of such an event, and income protection insurance becomes well worth investigating.

Some key areas of the policy you should consider and understand:

The type of contract

  • An indemnity option policy (generally) pays the lesser of the monthly insured benefit or 75% of the best 12 consecutive months income from the previous three years. The payment under this option is taxable, but the premiums are deductible.
  • An agreed value option pays an agreed amount (usually set at around 55% of your gross income at the time the policy is established). While the tax treatment of this option is open to debate, the payment under this option is not generally taxable, and therefore the premiums are not deductible.

Disability and Benefit Definitions
Insurers' definitions of these terms do differ. Review your insurer's definitions for total and partial disablement, and for the benefits payable under each scenario. These are the most important terms in any policy.

Waiting Period
Benefits generally become payable after four weeks, but a waiting period of up to 13 weeks can reduce the cost of premiums considerably.

Inflation Indexation
Ensure that your benefit increases with the rate of inflation - both while your policy is in force and while you are on claim.

Other Benefits
There are many other benefits and options attached to income protection insurance. These range from booster benefits, through to assistance with retraining.

Some Advice

  • Buy income protection insurance as soon as possible. The longer you leave it, the greater the chance that you will develop a condition that increases the premium, is excluded from the policy, or prohibits you from buying the insurance at all.
  • Entering income protection insurance in your late fifties may become prohibitively expensive. If you can afford it, consider a level premium option. The premium won't increase each year on the basis of your age.
  • Income protection insurance cover can be relatively expensive and complicated. Seek the assistance of an adviser. Have them walk you through the policy wording.
  • Every policy is different. Ask your adviser how your policy compares with other leading policy choices. Your adviser should understand what is important to your particular needs.
  • Consumer magazine featured an article on income protection insurance this month which contains useful information.