Understanding how income protection works, what it covers, and how to determine the right level of cover for your needs.
Income protection insurance is one of the most valuable types of insurance for working Australians, yet it’s often overlooked. This guide explains how it works and why it should be considered by anyone who relies on their income.
What is Income Protection Insurance?
Income protection insurance provides a regular income stream if you’re unable to work due to illness or injury. It’s designed to help you maintain your lifestyle and meet financial obligations while you’re recovering and unable to earn your usual income.
Unlike trauma insurance, which provides a lump sum payment for specific illnesses, income protection offers ongoing monthly payments (typically up to 70% of your regular income, with some policies allowing up to 90% for the first six months) for a specified period.
Why Consider Income Protection?
- Around 1 in 3 Australians will be unable to work for more than three months due to illness or injury before reaching retirement age.
- The average household could maintain its lifestyle for only 12 weeks if income stopped.
- Government support such as Centrelink sickness or disability payments is usually not enough to cover typical household expenses.
How Income Protection Works
Here’s how income protection insurance typically functions:
- You become ill or injured and are unable to work.
- You wait out the waiting period (also called the elimination period), which is the time between when you stop working and when benefits start.
- You receive monthly payments (typically 70–75% of your pre-disability income) for the duration of your illness or injury, up to the maximum benefit period.
- Benefits continue until you return to work, reach the end of your benefit period, or reach the policy expiry age (commonly 65).
Key Policy Features
Benefit Amount
Most policies pay 70–75% of your pre-tax income. For example, if you earn $100,000 per year, your monthly benefit would be approximately $5,833–$6,250.
Waiting Period
The period between when you stop working and when benefits begin. Common waiting periods:
- 14 days
- 30 days
- 60 days
- 90 days
- 180 days
- 1 year
- 2 years
A longer waiting period lowers your premium. Consider your sick leave, annual leave, and savings when choosing.
Benefit Period
The maximum length of time you can receive benefits for a single claim. Common benefit periods:
- 1 year
- 2 years
- 5 years
- To age 65 (or policy expiry age)
Longer benefit periods provide more comprehensive protection but increase premiums.
Waiting Period vs Benefit Period
Waiting Period
- Time before benefits start
- Short = higher premium
- Long = lower premium
- Consider emergency savings and leave entitlements
Benefit Period
- Maximum time benefits are payable
- Short = lower premium
- Long = higher premium
- Consider the financial impact of long-term disability
Policy Definitions
Own Occupation
You’re considered disabled if you can’t work in your specific occupation, even if you could work elsewhere.
Example: A surgeon with hand tremors who can’t perform surgery would receive benefits, even if able to teach medicine.
- Most comprehensive definition, usually more expensive.
Any Occupation
You’re considered disabled only if you can’t work in any occupation for which you’re reasonably suited by education, training, or experience.
Example: A surgeon with hand tremors may not qualify if they could reasonably work as a general practitioner or consultant.
- Less comprehensive, usually cheaper.
Hybrid Definition
Some policies start with “own occupation” for a set period (e.g. two years) and then switch to “any occupation.”
- A compromise between affordability and coverage.
Indemnity Value vs Agreed Value
Due to APRA’s 2021 changes, new income protection policies in Australia are generally indemnity value only.
Indemnity Value
- Benefit is based on income at claim time (usually past 12 months).
- Lower premiums.
- Risk of reduced benefit if income falls before claim.
Agreed Value (Legacy Policies)
- Benefit agreed at application, regardless of future income.
- Higher premiums, but guaranteed benefit.
- No longer available for new policies after October 2021.
- If you hold one, it may be worth retaining as terms are often more favourable than new indemnity policies.
Additional Features to Consider
- Partial Disability Benefits – pays a portion if you can work part-time or at reduced capacity.
- Rehabilitation Benefits – additional payments to cover rehab programs or equipment.
- Indexation – benefit increases annually with inflation.
- Future Insurability – allows cover increases at major life events without medical underwriting.
- Recurrent Disability – if you relapse within 6–12 months, the waiting period is waived.
2021 APRA Regulatory Changes
Reforms introduced in October 2021 included:
- Removal of agreed value policies for new applications.
- Income assessment based on the 12 months prior to claim.
- Maximum replacement ratio of 90% for the first six months, then 70% thereafter.
- Stricter terms for long benefit periods.
If you have a pre-October 2021 policy, it may have more favourable conditions than those available today.
Tax Treatment of Income Protection
- Premiums (outside super): Usually tax-deductible.
- Benefits: Taxable as ordinary income.
- Inside super: Premiums are deducted from your super balance (not personally deductible). Benefits may be taxed differently depending on circumstances.
Always seek professional tax advice for your situation.
Determining Your Coverage Needs
- Calculate essential monthly expenses: mortgage or rent, utilities, groceries, transport, education costs, insurance.
- Consider savings: How long could you manage without income?
- Evaluate other income sources: partner’s income, sick leave, or government benefits.
- Select a waiting period: based on leave entitlements and savings.
- Choose a benefit period: consider age, occupation, and financial commitments.
Income Protection Inside vs Outside Super
Inside Super
- Premiums paid from super balance (no cash flow impact).
- Often cheaper, but stricter definitions.
- Claims process may be slower.
- Reduces retirement savings.
Outside Super (Retail)
- Premiums paid directly, usually tax-deductible.
- More comprehensive and customisable.
- Faster claims processing.
- Direct cash flow impact, generally more expensive.
Many advisers recommend combining both: basic cover in super for affordability, with additional cover outside super for flexibility.
Making a Claim
- Notify your insurer as soon as possible.
- Complete claim forms.
- Provide medical evidence (doctor’s reports).
- Submit financial documents proving pre-disability income.
- For ongoing claims, provide regular medical and financial updates.
Processing times vary but typically take 2–4 weeks once all documentation is received.
Working with a Financial Adviser
A financial adviser can help you:
- Determine the right level of cover for your needs.
- Compare policies across insurers.
- Structure cover efficiently for tax purposes.
- Guide you through applications and underwriting.
- Provide ongoing reviews as circumstances change.
- Support you at claim time.
