Making the decision to become self-employed can be daunting, especially if you’ve been an employee on a regular salary with all the perks that can bring, like a pension, holidays and sickness pay.
The transition from this relative security to going it alone is not always easy, but there are steps you can take to help protect you financially should the need arise, allowing you to concentrate on growing and developing your business.
Are you a sole trader or limited company director?
If you’re a sole trader (or member of a partnership) or want to take out income protection personally (out of your post-tax income), this guide is aimed at you.
If you work via your own limited company, you may be interested in setting up cover via your business – which is a tax-efficient way to protect yourself. You can find out more in our income protection guide for limited company directors.
What is Income Protection Insurance?
Income protection insurance will protect up to 70% of your income if you were to suffer an accident or become too ill to work. It is also possible to cover yourself in case of unemployment, and some policies cover accidents, sickness and unemployment in one.
Income protection policies can be either short- or long-term, with the former protecting you for a fixed period if you are unemployed or unable to work, and the latter protecting you until you die if you are seriously ill and unable to ever work again.
Income protection insurance is also split into four product areas:
- Payment Protection Insurance: Covers loan or credit card payments for the period you are unemployed or unable to work
- Mortgage Protection Insurance: Covers mortgage repayments during the period you are unemployed or unable to work
- Loan Protection Insurance: Only covers loan payments for the period you are unemployed or unable to work
- Unemployment Protection Insurance: Covers a proportion of your salary whilst you are unemployed or unable to work
Understanding how and when to go about taking out income protection insurance, whether as a sole trader or a small start-up company, is an important aspect of protecting yourself against any unforeseen circumstances.
Accidents and illness are inherently unpredictable, and with no employer to provide sick-pay it is essential that you are able to provide for yourself, and also your family, should an incident occur.
As with any insurance policy, there is a lot to know about income protection and the factors that could affect your premium. Many of these will be beyond your control such as age, medical history, family health history, occupation, and how long you have been self-employed. There are, however, some practical aspects that you can control.
One of the first things you will need to decide is which one of the three types of occupation class you want covered:
- Own occupation: You will be covered by your policy if you are unable to work in your specified occupation
- Suited occupation: Your policy will pay out if you are too ill to work in your own expertise or in a field that requires similar experience
- Any occupation: You will only receive benefits if you are deemed unfit to fulfil any category of paid work.
Think carefully if you are tempted to select ‘any occupation’. It offers lower premiums, but you probably want coverage for when you are unable to do your own job, not merely any job.
Bear in mind that income insurance will only cover up to 70% of your pre-tax earnings (this percentage is of your ‘take-home’ profits, not your business’s revenue).
Some insurers even limit the annual benefit below £18,000. So if you are looking for a high coverage amount make sure to check the insurer’s policy wording carefully, and remember that an increase in coverage will usually also lead to a higher premium to pay.
Additionally, be aware that different insurers may average your previous earnings over varying time frames. So if your income fluctuates, this can influence which insurer might be best for you.
Types of policy
It’s important to get the right policy for your specific needs. The types of policy and premium you will pay are as follows:
The premium on this policy will stay fixed over the life of the policy. These policies tend to be expensive in the short term but cheaper over the medium to long term
Reviewable policies, as the name suggests, are reviewed every year and tend to work out cheaper in the short term but more expensive in the long term as you get older and are seen as more of a risk
Similar to reviewable policies but you’ll know beforehand how much your premiums will go up year on year. Popular for those with dangerous occupations who pay higher premiums anyway.
Another factor that will affect your premium is the deferred period option. ‘Deferred period’ refers to the length of time from when you stop working to when your policy begins paying out.
Most deferred periods are between 4, 13, 26 or 52 weeks. Being self-employed and without the benefits of sick-pay, insurers may offer you a shorter deferred period. If you can afford it however, it may be best to prolong the deferred period as much as possible, since the longer the deferral period, the cheaper the policy will tend to be.
Duration of coverage
Nobody knows how long they will be unable to work for following an illness or injury. This means that weighing up the benefits and drawbacks of long-term vs. short-term cover is important to consider.
Most short-term protection policies will provide a monthly pay-out for a predetermined period, usually up to 12 months.
Long-term coverage, depending on your policy, can last until the day you resume work or until you reach retirement age. Unsurprisingly, the longer the duration of coverage the higher your premium will be.
IP Insurance is only paid after sick pay is taken into account, so as a self employed person or small business owner it can serve as a safety net where these benefits aren’t available to you.
It’s also worth bearing in mind that protection insurance payouts do not take into account social security benefits and income support that are paid by the state, although the payouts themselves may affect your ability to claim these benefits in the first place.
Other options in your policy could include cover for terminal illness or death as well as funding to help you retrain and find a new job.
It’s more likely that you’ll need income protection if you’re self employed or a small business owner as you won’t have the safety net of employee benefits such as a redundancy package or sick pay sick pay to fall back on.
As pessimistic as it might seem, it’s very prudent to think about the consequences of your business going under and how you would support your family and maintain mortgage or rent payments were you to lose this income.
Going into business is not without its financial risks and so it makes good business sense to plan for the future by protecting your income in this way.
This article was written for ByteStart by Matt Sanders, Gocompare’s income protection insurance spokesperson. He comments extensively on a whole range of money matters and closely follows the latest changes and trends in the sector.