How Much Income Protection Do I Need?
Working Out How Much of Your Income You Should Protect
Your income supports almost everything else in your financial life.
It pays the mortgage or rent, household bills, food, transport, childcare, insurance and everyday expenses. It may also fund savings, pensions, holidays and longer-term plans.
If illness or injury prevented you from working, many of those commitments would continue even though your earnings could reduce significantly.
That leads to an important question:
How much income protection do I actually need?
The answer is not simply your salary.
Income protection is generally designed to replace part of your earnings, and the appropriate level of cover depends on your expenditure, employer benefits, savings, household income and the amount an insurer is prepared to cover.
This guide explains how to assess your potential income protection need.
Start With Your Essential Monthly Expenditure
A useful starting point is understanding how much money your household actually needs each month.
Consider essential commitments such as:
mortgage or rent;
council tax;
gas and electricity;
water;
food;
transport;
childcare;
insurance;
loan repayments;
minimum credit commitments;
essential subscriptions; and
other regular household expenses.
This gives you an indication of the minimum income required to keep the household functioning.
Don't Start With Your Salary
Suppose somebody earns £4,000 per month.
That does not automatically mean they need or can obtain £4,000 per month of income protection.
Their essential household expenditure might be considerably lower.
They may also have:
employer sick pay;
savings;
a partner's income;
existing insurance; or
other financial resources.
The objective is to understand the financial shortfall created if they cannot work.
Income Protection Does Not Normally Replace All of Your Earnings
Income protection is generally designed to replace part of your earnings rather than your entire income.
Insurers set limits on the amount that can be insured.
The precise calculation and maximum benefit can vary between insurers and can depend on how your income is earned.
This is particularly relevant for:
employees;
self-employed people;
company directors;
contractors;
people receiving bonuses;
people earning commission; and
people with variable income.
The amount you would like to protect and the amount an insurer will allow you to protect are therefore not necessarily identical.
Step One: Work Out What You Spend
Look at what actually leaves your household each month.
Separating expenditure into categories can help.
Essential Expenditure
These are expenses that would be difficult to stop immediately:
mortgage or rent;
utilities;
food;
childcare;
transport;
insurance;
debt repayments; and
basic household costs.
Discretionary Expenditure
These might include:
entertainment;
eating out;
holidays;
non-essential subscriptions;
hobbies; and
other lifestyle spending.
If income stopped, some discretionary expenditure could potentially be reduced.
Essential expenditure is therefore often the more important starting point.
Step Two: Check Your Employer Sick Pay
If you are employed, find out exactly what happens if illness prevents you from working.
Do not simply assume your employer provides "good sick pay."
Establish:
whether you receive full salary;
how long full salary continues;
whether reduced salary follows;
how long reduced salary lasts; and
when employer support ends.
This information can significantly affect how income protection should be structured.
Why Sick Pay Matters
Imagine your employer provides full salary for an initial period and then reduces your pay before eventually stopping it.
You may not need an income protection benefit from the first few weeks of absence.
Instead, the policy could potentially be structured so that its deferred period works alongside your employer benefits.
This can help avoid paying for a policy structure that does not match your actual financial need.
Step Three: Understand Your Deferred Period
The deferred period is the period you generally need to be unable to work before the income protection benefit begins.
Choosing an appropriate deferred period is just as important as choosing the amount of cover.
A shorter deferred period may provide benefits sooner but can affect the premium.
A longer deferred period may reduce the cost, but you need sufficient resources to support yourself while waiting.
How Long Could You Manage Without Your Normal Income?
Ask yourself:
If my salary stopped today, how long could I continue paying my bills?
Consider:
employer sick pay;
emergency savings;
partner's income;
other household income;
existing protection; and
accessible financial reserves.
This can help establish an appropriate deferred period.
Step Four: Consider Your Savings
Savings can provide valuable short-term protection.
But they are finite.
Imagine a household has £12,000 in accessible savings and requires £3,000 each month to maintain essential expenditure.
Without any other income, those savings could reduce rapidly.
The figures are deliberately illustrative, but they demonstrate an important principle:
An emergency fund and long-term income protection solve different problems.
Savings can help absorb a short disruption.
Income protection can be designed to address a potentially much longer period of incapacity.
Do You Want to Spend Your Savings if You Become Ill?
This is another important consideration.
You may technically have enough savings to survive for several months.
But what were those savings intended for?
Perhaps they were for:
emergencies;
home improvements;
children's future;
retirement;
another property;
business investment; or
general financial security.
Using those savings to replace lost income can fundamentally change your longer-term financial position.
Step Five: Consider Your Partner's Income
For couples, income protection should be considered at household level as well as individual level.
If you stopped working, could your partner's income cover everything?
If the answer is yes, the financial shortfall may be smaller.
If the household relies heavily on both salaries, losing either income could create immediate pressure.
Consider what proportion of the household's expenditure depends on each person's earnings.
Don't Assume the Lower Earner Doesn't Need Protection
It is easy to focus exclusively on the highest earner.
But the lower salary may still pay for:
childcare;
food;
utilities;
transport; or
other essential expenditure.
Removing that income could still leave a significant shortfall.
Protection should therefore be considered for each working person based on their contribution to the household.
Step Six: Consider Your Mortgage or Rent
Housing is often the largest monthly household expense.
Ask:
How would the mortgage or rent be paid if my income stopped?
For homeowners, income protection can potentially help maintain regular mortgage payments.
For renters, it can potentially help maintain rent payments.
This is why income protection is not exclusively a mortgage-related product.
Step Seven: Consider Other Debts
Your mortgage may not be your only commitment.
There could also be:
personal loans;
car finance;
credit cards;
business borrowing; or
other regular repayments.
These commitments usually continue even when income falls.
They should therefore be included when assessing how much regular income the household needs.
Step Eight: Consider Your Children
Children can make a household particularly dependent on consistent income.
Expenses may include:
childcare;
food;
clothing;
transport;
school-related costs;
activities; and
general living expenses.
If illness prevents you from working, childcare requirements could also change.
For example, your partner might need to reduce their own working hours to provide additional support.
The financial effect can therefore extend beyond simply losing your salary.
Step Nine: Review Existing Insurance
You may already have protection that could help.
Check for:
personal income protection;
employer-provided income protection;
critical illness cover;
other workplace benefits; and
relevant existing policies.
Understanding what you already have helps identify the remaining financial gap.
Does Critical Illness Cover Replace the Need for Income Protection?
Not necessarily.
Critical illness cover and income protection solve different problems.
Critical illness cover generally pays a benefit following diagnosis of a specified condition that meets the policy definition.
Income protection is designed around inability to work because of illness or injury.
You could potentially be unable to work without experiencing a condition that results in a critical illness payment.
Having critical illness cover therefore does not automatically mean your income is protected.
Does Life Insurance Replace the Need for Income Protection?
No.
Life insurance primarily addresses the financial consequences of death.
Income protection addresses the financial consequences of being alive but unable to work because of illness or injury.
They protect against different risks.
How Much Income Protection Can an Insurer Provide?
Each insurer has its own rules.
The amount available may depend on:
earnings;
employment status;
occupation;
existing protection;
other benefits;
policy structure; and
insurer criteria.
Rather than assuming a fixed percentage of salary will always be available, the current insurer criteria should be assessed.
Income Protection for Employees
For an employee, establishing income can often be relatively straightforward.
Evidence might include:
payslips;
employment details;
salary;
contractual earnings; and
other eligible remuneration.
However, variable earnings such as bonuses, overtime or commission may be treated differently depending on the insurer.
What If My Income Includes Bonuses or Commission?
Variable earnings can make the calculation more complicated.
An insurer may consider:
how regularly the income is received;
how long you have received it;
previous earnings history; and
its own definition of insurable income.
You should not assume that every pound appearing on a payslip will automatically be included when determining the maximum benefit.
Income Protection for Self-Employed People
Self-employed income can fluctuate.
An insurer may therefore need to establish a sustainable level of earnings rather than simply relying on one particularly strong month.
Depending on the circumstances, evidence could include accounts, tax information or other proof of earnings.
Requirements vary between insurers.
Why Income Protection Can Be Particularly Important When Self-Employed
If an employee becomes ill, they may have employer sick pay.
A self-employed person may have no equivalent.
Income could reduce almost immediately.
At the same time, there may be both household and business expenditure to consider.
This can make the consequences of being unable to work particularly significant.
Income Protection for Company Directors
Company directors can have more complicated remuneration structures.
A director might receive income through a combination of salary and other payments.
Different insurers can assess director income differently.
The company's financial position may also be relevant depending on the type of policy and arrangement.
This means the maximum amount of income protection available can vary between insurers even where the underlying circumstances are the same.
Income Protection for Contractors
Contractors can also have different working and income arrangements.
The insurer may consider:
contract structure;
occupation;
earnings history;
employment status;
length of contract; and
how income is received.
Selecting the appropriate insurer can therefore involve more than simply comparing premiums.
What If My Income Changes?
Income protection can remain in place for many years.
During that period you might:
receive promotions;
change employers;
increase your salary;
reduce your hours;
become self-employed;
become a company director; or
change occupation.
A policy arranged years ago may no longer reflect your current income.
This is why protection should be reviewed periodically.
What If My Income Increases?
If your earnings increase significantly but your insured benefit remains unchanged, you may become underinsured.
The amount provided by the policy may represent a smaller proportion of your income and expenditure than when it was originally arranged.
Depending on the policy, options may exist to increase cover, sometimes subject to particular conditions.
The exact terms should be checked.
What If My Income Falls?
This can be equally important.
Income protection is linked to earnings.
If your income has fallen substantially, the amount payable following a claim may potentially be affected depending on the policy terms.
Having a policy showing a particular benefit does not always mean that amount will automatically be payable regardless of your earnings at the time of claim.
The policy terms need to be understood.
Should My Income Protection Increase With Inflation?
If you intend to keep income protection for many years, inflation can matter.
A fixed benefit may buy considerably less in the future.
Some policies allow the insured benefit to increase using an inflation-linked or other specified mechanism.
Premiums can also increase.
This is often referred to as indexation.
The objective is to help the protection maintain its real-world value over time.
What Is RPI Indexation?
Some policies may use the Retail Prices Index as part of their mechanism for increasing cover.
Where applicable, the insured benefit can increase over time in accordance with the policy's indexation rules, helping it respond to rising living costs.
Premiums will normally change as the benefit changes.
The precise calculation, limits and index used depend on the policy.
How Long Should the Benefit Be Payable?
The amount of monthly cover is only one part of the decision.
You also need to consider how long a valid claim could potentially be paid.
Some policies provide a limited payment period for each claim.
Others may potentially continue paying for much longer while the claim remains valid, subject to the policy terms.
Why the Benefit Period Matters
Imagine two policies provide the same monthly benefit.
One can provide that benefit for a limited period per valid claim.
The other can potentially continue paying for a much longer period.
They may look similar when comparing the monthly benefit alone, but the long-term financial protection can be substantially different.
This is why price and benefit amount should never be considered in isolation.
How Long Should the Policy Last?
Income protection is usually protecting your ability to earn.
The policy term can therefore be considered in relation to:
expected retirement;
working life;
mortgage term;
financial independence; and
other long-term plans.
Someone expecting to remain dependent on employment income for many years may have a different need from someone approaching financial independence.
What Is Own Occupation Cover?
The definition of incapacity is crucial.
An own occupation definition assesses whether illness or injury prevents you from carrying out your own occupation according to the policy terms.
This can be particularly important for people with specialist occupations.
Being capable of performing some form of work does not necessarily mean you can perform your normal job.
Policy definitions should therefore be understood carefully.
Should I Protect Only Essential Bills?
That is one possible approach.
Protecting enough income to cover essential expenditure can provide a financial safety net while keeping premiums manageable.
However, some people may want broader protection that allows the household to maintain more of its normal lifestyle.
The appropriate balance depends on:
need;
available cover;
existing resources; and
budget.
Essential Protection vs Lifestyle Protection
It can help to think about income protection in layers.
Essential Protection
Enough to help cover core financial commitments such as housing, food, utilities and essential transport.
Broader Protection
A higher level designed to preserve more of the household's normal lifestyle, subject to insurer limits.
Neither approach is automatically right.
The objective depends on your priorities and budget.
What If I Can't Afford the Maximum Cover?
You do not necessarily need to abandon income protection entirely.
The policy can potentially be structured around the most important financial risks.
Options may include considering:
a lower benefit;
a longer deferred period where appropriate;
a different claim period;
existing employer benefits; and
the most essential household expenditure.
Any reduction in protection should be understood because it changes the amount of risk you retain yourself.
The Cheapest Policy May Not Provide the Best Protection
Two income protection policies offering apparently similar monthly benefits can operate differently.
Consider:
definition of incapacity;
deferred period;
maximum claim period;
policy term;
indexation;
exclusions;
underwriting;
rehabilitation support; and
additional policy features.
The amount of monthly benefit is important, but it is only one part of the policy.
An Illustrative Income Protection Calculation
Imagine someone receives £3,500 per month in earnings.
Their household's essential monthly expenditure is £2,400.
Their partner contributes towards household expenses, and they have an emergency fund available.
The objective might not necessarily be to replace the full £3,500.
Instead, the discussion could consider:
what expenditure genuinely needs protecting;
what contribution continues from the partner;
how long savings could bridge the gap;
whether employer sick pay exists;
what maximum benefit insurers would permit; and
how long the benefit should potentially be payable.
This example is purely illustrative and is not a recommendation.
Don't Forget Tax Treatment
The taxation of insurance benefits can depend on how the policy has been arranged and who pays the premiums.
Personal policies and arrangements involving businesses can operate differently.
Tax rules can also change.
Where tax treatment is relevant, the specific policy structure and current rules should be checked, and appropriate tax advice obtained where necessary.
Review Income Protection Regularly
Your income protection requirements can change substantially over time.
Consider reviewing your policy after:
a pay rise;
promotion;
changing employer;
changing occupation;
becoming self-employed;
forming a company;
having children;
buying a property;
moving home;
increasing your mortgage;
reducing your working hours; or
significant changes to household expenditure.
A policy designed around your circumstances several years ago may no longer provide the protection you expect.
Don't Automatically Replace an Existing Policy
An existing income protection policy can be valuable.
It may have been arranged when:
you were younger;
your health was different;
your occupation was different; or
different policy terms were available.
Replacing it means undergoing new underwriting.
The new policy could contain different exclusions, premiums or definitions.
Existing protection should therefore be reviewed carefully before replacement.
Never Cancel Existing Protection Before New Cover Is in Place
A new application is not guaranteed to be accepted.
The insurer may request additional medical information or offer terms different from those expected.
Existing protection should generally remain in force until replacement cover has been accepted, has started and the consequences of replacing the original policy are understood.
A Practical Income Protection Calculation
When considering how much income protection you may need, work through these areas:
Your Income
Consider:
salary;
regular eligible earnings;
variable income;
self-employed earnings; or
director remuneration.
Essential Monthly Expenditure
Consider:
mortgage or rent;
household bills;
food;
transport;
childcare;
insurance; and
debts.
Existing Support
Consider:
employer sick pay;
savings;
partner's income;
existing insurance; and
other financial resources.
The Protection Structure
Consider:
monthly benefit;
deferred period;
maximum claim period;
policy term;
definition of incapacity;
indexation; and
affordability.
The difference between what you need and what your existing resources can provide helps identify the potential protection shortfall.
Questions to Ask Yourself
Before deciding how much income protection you need, consider:
What would happen if my salary stopped tomorrow?
How much does my household genuinely need each month?
How long would my employer pay me?
How long would my savings last?
Could my partner's income support the household alone?
How would we pay the mortgage or rent?
What happens if I cannot work for several years rather than several months?
Does my existing protection already cover part of the risk?
How much monthly premium can I sustainably maintain?
The answers provide a much stronger foundation for protection planning than simply selecting an arbitrary amount of cover.
Speak to Cambs Ely Mortgages About How Much Income Protection You Need
Working out how much income protection you need involves understanding your income, household expenditure, mortgage or rent, employer sick pay, savings, dependants and existing protection.
We can discuss these areas with you and consider the amount and structure of protection appropriate to your circumstances and budget.
Cambs Ely Mortgages provides mortgage and protection advice to clients in Ely, Cambridge, Cambridgeshire and across England, with remote appointments available.
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Important Information
The information contained in this guide is intended for general educational purposes and does not constitute personalised financial, insurance, medical, legal or tax advice.
Income protection policies vary between insurers. The amount of income that can be insured, benefit limits, definitions of incapacity, deferred periods, maximum claim periods, policy terms, exclusions, indexation and underwriting decisions depend on the insurer, policy and individual circumstances.
The benefit payable following a claim may depend on your earnings and circumstances at that time, subject to the terms of the policy.
Tax treatment depends on individual circumstances and how the policy is arranged and can change. Specialist tax advice should be obtained where appropriate.
Do not cancel existing protection until any replacement cover has been accepted, is in force and you understand the consequences of replacing the existing policy.