Income Protection for Contractors and Freelancers can provide a tax free monthly income to protect your current lifestyle if you are unable to work due to illness or injury.

Why is  Contractor Income Protection Necessary

As a contractor your income is dependant on your ability to turn up at your client’s site every morning. You don’t have any safety net to fall back on, like permies who enjoy “sick pay” benefits if they are not fit for work. Instead, you can source a policy called permanent health insurance (PHI) that pays out from the first day you are off sick.

Income replacement policies (PHI) might appear similar when applying for a quote but vary considerably. It is therefore essential that you get the right cover and not the cheapest policy quoted.

There are a couple of factors Contractors should look at before taking out an income protection policy.

How do I know this is the right policy for me?

This is a policy you simply can not afford to get wrong. Many of the policies available through financial institutions pay out solely on salary and so won’t be suited to your income as a Contractor. It is important that you find an insurance provider that understands your unique circumstances and offers a policy that is tailored to suit your contractor status and lifestyle.

Policies can vary in price depending on the extent of the cover and provider - always read the small print for the exclusions. Cost should never be the deciding factor when choosing a policy. A cheap policy may only pay out if you are deemed to be too ill to do any job or might only allow claims to be made as a result of very severe illness. This may not be adequate protection for many people. Policies must also be with an insurer that has an excellent claims record of actually meeting obligations to clients.

Dividends and salary

For tax reasons, many contractors working through a limited company will draw a low salary and derive the rest of their income in dividend payments in order to avoid higher rate tax. Some insurers exclude dividends as this is often deemed to be investment income so you should also check that dividend income is protected. It is important not to fall into this trap otherwise you could be paying premiums for cover you cannot claim.

‘Own’ not ‘Any’ Occupation

It is essential for Contractors to source a policy that provides cover on an “Own” not the cheaper “Any” occupation basis. Own occupation protects against an illness that stops you from specifically doing what you do now as opposed to many policies that suggest you are fit enough to work in the post room. ‘Any’ occupation means that despite your skill level and current income, an insurer would argue that you are still able to work in convenient store, stacking shelves and they will therefore stop a claim. This important issue is often overlooked by contractors looking at income protection insurance and can often mean that a cheaper quote doesn’t offer you an effective safety net.

Keeping costs to a minimum

If required, we can provide access to an Income Protection plan that pays out benefits on the very first day of any illness. The most effective way of reducing costs to a minimum, however, is to accept a waiting period before you begin to receive a pay-out. This delay is called the “deferment period” and the longer it is, the lower the cost. This option should be considered if you have savings that you can to fall back on. Options for the waiting period of the policy will be one, two, three, six and twelve months.

How long should I be covered for?

This would depend on your personal and financial circumstances, life style and expectations. It is important to guard against the impact of an injury or critical illness that would prevent you from returning to work and so you should consider a policy that will cover you into retirement.

Protection against inflation increases

It is essential to inflation proof the benefit you receive should you need to make a claim. Whilst it is cheaper to select Level term this means that if you make a claim your benefit will stay at the same amount over time. The amount of benefit that a policy holder might receive at the beginning of a claim could of course be worth considerably less over time if it does not keep pace with inflation. It is therefore essential to inflation proof your policy so that the payment increases at the rate of inflation and will give you the same monthly spending power for the life of your policy.

Do I select guaranteed or reviewable premiums?

This relates to the cost of premiums you pay for a policy. There are two options Guaranteed or Reviewable. If you select Guaranteed the premium will not increase unless you choose to increase the amount of cover that you have, and the Insurer guarantees that it won’t increase. If you select Reviewable the Insurance provider can increase the premium that you pay at their discretion.

Who pays the premium - me or my company?

You have the choice of how you pay for your policy and this is another issue for the Contractor to take into account. It is possible to pay for the cover personally from your net income, Personal Cover, in which case benefits paid are tax free. Alternatively you can apply for Executive Cover and pay for the premiums from your limited company account, in which case benefits enter the company tax free but then you pay tax and national insurance on any benefit that is drawn as income. If you choose to pay out of the company account you can insure up to 75% of income and the premium payment, although a business expense, is not a payment in kind benefit.

As with most insurance policies, the exact premium you pay will depend on your age, sex (women pay more for income protection policies than men), current health and lifestyle (do you smoke, drink more than recommended guidelines and so on). However, unlike other policies, your occupation will also have a significant bearing on the cost of cover. Given the high number of claims for back problems, those in more physical jobs, such as building work, will pay more.

As a contractor, your entire lifestyle rests on the ability to be able to fall back on an income protection policy when you need it. We have given you an overview of the issues concerning PHI. You have no employer safety net to fall back on. If you are willing to insure your car, your home and your belongings, it’s only common sense to insure the income that is ultimately used to pay for those things. Your ability to work and earn an income is vital to continue your lifestyle and protect your family.

Freelancer Financials, are Independent Financial Advisors who specialise in providing timely, jargon free solutions, tailored to the needs of contractors. To speak to John Yerou about your protection needs, call 020 8421 7999 or email john@freelancerfinancials.uk.com.