How Income Protection For The Self-Employed Works

Discover the benefits of income protection for small business owners in our jargon-free guide.

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Graham Cox - Founder & Cemap Mortgage Advisor |
Graham Cox
CeMAP Mortgage & CPSP Specialist Finance Advisor

When you're self-employed, it's crucial to consider how you'd support yourself and your family if you were incapacitated due to illness or injury.

For example, If you couldn't work in your business, could you still pay yourself dividends to cover the mortgage or bills? If not, how long would any savings last if there was no income coming in?

If you're at all concerned about how you'd manage, an income protection (IP) policy could be the perfect solution.

And it's not just for homeowners either.  Income Protection can be just as useful if you rent your home.

This guide explains what income protection is, how it works and the different options available. It also examines key features of IP, such as deferment periods, and how the maximum monthly benefit is calculated.

What is Income Protection Insurance?

Think of Income Protection Insurance as sick pay for the self-employed. An income protection policy provides you with a monthly, tax-free, income if you're unable to work in your chosen profession due to illness, injury, or disability.

Sometimes referred to as Permanent Health Insurance, or PHI (not to be confused with Private Medical Insurance or PMI), Income Protection covers a broad range of illnesses and injuries including, but not limited to:

  • Back pain and other musculoskeletal problems
  • Mental illness, including depression or stress-related issues
  • Stroke
  • Cancer
  • Heart Attack or Disease
  • Fractured bones

In fact, IP will cover you for a very broad range of illness or injury that prevents you from working in your business, as long as you've been signed off work by a GP or other medical practitioner.

The only caveat is that medical exclusions can be applied to pre-existing conditions, or if there is a family history of such a condition or illness.

How does income protection work for the self-employed?

Income Protection allows you to choose the monthly benefit level you want to receive, up to the insurer's maximum percentage of your current gross monthly income, typically 65 percent.

Others permit 65 or 70 percent up to a certain income level of around £60,000 p.a, then a lower percentage on anything above.

In the event of a successful claim, the benefit is paid tax-free every month until you return to work, retire or pass away during the policy term, or the policy term expires.

You can make an unlimited number of claims during the term of the policy. Even if it's a reoccurrence of the same condition that prevented you from working initially. Cancer or back pain for example.

How the maximum monthly benefit is calculated

Your maximum benefit amount is calculated using your personal tax calculation for the latest year at the point of application.

For example, a director with a 22/23 tax year income (salary and dividends) of £62570 per annum, could potentially qualify for a maximum benefit amount of £3389.20 per month at 65% of gross income.

The calculation is gross annual income x maximum percentage, divided by 12. In the above example: (62570 x 0.65) / 12.

You could of course, choose a lower benefit figure, reducing your monthly premium accordingly.

What happens when I claim on my Income Protection policy?

When you claim, the same calculation will be run using your income for the 12 months before becoming incapacitated.

If your income has reduced from when when you took out the policy, you'll receive a lower monthly benefit, though some providers guarantee a minimum benefit level, typically around £1500 a month.

If your income has increased, you'll still only receive the maximum benefit amount you applied for initially.

Setting a deferment period

The deferment, or wait period, is how long you must wait to receive your first benefit payment after becoming incapacitated. The longer the deferment period, the lower the premium.

It's possible to set a deferment period of one day, all the way up to two years. In reality, most self-employed applicants choose one, two or three months.

To determine a suitable deferment period, you'll need to consider how long you can comfortably pay your mortgage (or rent) and other bills if you're income reduces or stops altogether. Bear in mind, savings can dwindle rapidly with nothing coming in, and in any case, you may not want to risk using them all up.

Standard vs Short-Term Income Protection

Standard Income Protection, a.k.a Full Cover to Term IP, pays you the benefit amount each month during the policy term until you return to work, retire or pass away.

So potentially you could receive the payment for many years, even decades.

Short-Term IP on the other hand, typically pays you for a maximum of two years per claim. So whilst it's cheaper than standard IP, it does mean payments will stop after two years, even if you're still unable to return to work at that point.

You can still make multiple claims during the policy term, but each claim will only pay out for a maximum of two years.

How much does income protection cost?

How much you pay for income protection depends on your circumstances, needs and preferences, but policies can start from just a few pounds a month.

Factors affecting your premium include:

  • The policy term
  • Your occupation
  • The percentage of income you want covered
  • Your health, including any pre-existing conditions
  • The deferment period
  • Whether you want Standard IP or Short-Term IP

Guaranteed vs Reviewable Premiums

There are two main types of premium with Income Protection.

With guaranteed premiums, the amount you pay each month doesn't change, unless you amend the policy during the term. For example, if you changed the term or increased the benefit amount, then the insurer would amend the premium accordingly.

Reviewable premiums work differently. Typically the insurance provider will review your policy every five years. So your premiums won't change for the first five years, but could increase or decrease on review, depending on a range of factors, including your medical history, advances in treatments and so on.

What are the qualifying criteria?

To take out Income Protection Insurance, you'll typically need to:

  • Be aged 18 to 59
  • Live and have your main home in the UK
  • Be a UK national or have settled/pre-settled status
  • Have been working in a self-employed or employed role for at least the past 12 months

Will I need to have a medical examination?

You won't need a medical examination in the vast majority of cases. However, you will need to complete an online medical questionnaire about your medical history and lifestyle during the application process with your adviser.  The questionnaire usually takes around 30 minutes.

Upon completion, the insurer will either insure on standard terms using the existing quote, or if you're deemed a higher risk, a more expensive quotation will be produced. The latter is known as a rated policy.

Sometimes the insurer will, with your consent, contact your GP or medical practioner before providing a revised quote. Occassionally, if the insurer deems the risk too high, the cover will be declined.

Getting an income protection quote

Income protection is possibly the most important insurance policy for anyone who's self-employed. After all, every other insurance policy you hold, for your car, life, health or home is dependent on maintaining your income.

At Self Employed Mortgage Hub, we can provide you with a tailored, no-obligation Income Protection quote, even if you have a complex medical history, or rare medical condition. Call 0117 205 0655 or complete our simple online quiz here today to get the ball rolling.

Graham Cox - MLIBF CeMAP Mortgage Adviser & Director of Hub FS Ltd

About the author

Graham Cox is the founder of Self Employed Mortgage Hub, the trading name of Hub FS Limited.

Based just north of Bristol, SEMH is an independent, whole of market broker and a true specialist in self employed mortgages, helping business owners across the UK get great mortgage and protection deals.

Graham's market commentary and analyis is regularly quoted in the national press and media, including The Guardian, Telegraph, FT Adviser, and BBC Radio Bristol.