133- How To Protect The Greatest Asset In Your Financial Plan (Income Protection Masterclass)

Income protection insurance is often thought of as too expensive and surplus to requirements, but this couldn't be further from the truth. 

It's not as complicated as it may seem and is absolutely vital for most people's financial plans. Without it, your financial plan carries an insurmountable amount of added risk, far greater than any stock market risk you're worried about. 

Don't be financially ignorant to the valuable role this planning can play. 

In 25 minutes Benjamin will help you to understand the fundamentals, sans jargon as always. 

Join Benjamin Mitchell (themoneyscot), serial hater of financial jargon, as he helps make your finances clearer and ensures you never make another financial mistake.

Getting on top of your personal finances doesn't need to be complicated or scary. Arm yourself with the only knowledge you need to transform yourself from money novice to money nerd! 

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Disclaimer - please note that nothing in this podcast can be relied upon as financial advice and the content is provided purely for information and guidance purposes. Please seek independent, regulated financial advice relevant to your situation.

Transcript

SPEAKER_00 0:10

Hello, money nerds, and welcome to another episode of Heads Up on Money. This week we're talking about what happens if your income suddenly stops. And where I'm getting at with this episode, I've teased you in is are you aware of what income protection is? Now I realize often when we think about insurance, we think, you know what, they never pay out. It's a waste of money. I could be using my money to better effect every month. What an absolute waste of money those premiums are. Jeez, that's expensive. I've seen it all in my career. But as I always say, when we're looking at the priorities of your financial planning, you pay off bad debts, you have an emergency fund in place, and then you start planning for the disasters. BED, that's one of the acronyms I will allow in financial planning. So one of the very first episodes I did of Heads Up on Money was putting the good stuff to bed. And when it comes to the D in bed disaster planning, looking to plan around your income and the risks of what happens to your financial plan if your income stops is incredibly important. And I beg of you just to bear with me for this week's episode to understand the risks that this may present to your financial plan. And plugging this risk perhaps isn't as costly or complicated as it might seem. So we're going to cover everything you need to know and do about income protection in this week's episode. And if you find it useful, if you found it enjoyable, dare I ask, enjoyable, then please share with your family and friends, or at the very least like, subscribe, and share the podcast. If I know this is landing well with you, money nerds, then I'll do follow-up episodes in the future on the other types of personal insurance products that you really should be considering as part of your financial planning. But let's get into this one. It's your masterclass on income protection. So if we regroup here before we get into the details of income protection, because that sounds like a fairly dull product that often you probably think an insurance salesman will be trying to flog to you, but the reality is it's an incredibly vital product that most people should have. And the reason for this is if I pose the question to you, and I've done it in previous episodes of the podcast, so if you're a diligent and dedicated money nerd, you'll know the answer to this. If I said, okay, what is the greatest asset to your financial plan? Is it a your pension? Pretty important, got to be. Quite a lot of people have quite a lot of money in their pensions. Is it your family home? Ooh, that's a good one, Benjamin. You know, we have got a lot of wealth tied up in the family home. We love bricks and mortar in the UK. Or is it yourself? The answer of course is you. You're the greatest asset to your financial plan, particularly when you're in the stage of growing your wealth, because you are the means by which income comes into the financial plan that then goes out to the financial products you hold, pensions, ISAs, investment bonds, GIAs, whatever they may be, and all the great things I talk about, the correct asset classes to invest in, equity investing, coattails, riding on the highs of the stock market over the long term, all of that stuff doesn't work if you don't have income coming in. Of course, you may be fortunate in such that you have inherited a lump of capital, but we're looking at this through the lens of for most people, the success of their financial plan is contingent on you continuing to work, on you or your partner continuing to have incomings to the financial plan to do all the great financial planning in the background. And you need to ask yourself if you suddenly found yourself unable to work due to an illness or an injury, then could you survive financially? And so many people are ignorant to that because they think, you know what, I'm gonna be okay. The most common one I have, and the pushback I get from clients when I start to frame this with them, is you know what, I've got my employer, they're gonna have my back. Well, some employers offer versions of income protection, sometimes at reduced terms, so for only covering a few years, because of course the cost to the employer long term could be significant. So you may have some version of income protection. I've rarely seen in my life a decent full bells and whistles income protection product that's provided through an employer without you paying for that or having some cheap and cheerful version of it, is more often the case, and you think you've got full income protection, you probably don't. And what about the state? You probably think, you know what, if I'm if I'm out of work long term, then the state will have my back, the government's got my back. Well, the reality is they don't. Often what happens with people is you may have a period of sick leave that will be paid by your employer, but if you're off an extended sick leave, you'll typically go down to just the statutory sick leave amount, which is more often than not going to be an absolute fraction of the salary or the income that you've become accustomed to and your financial plan is built on. Would you also have enough in savings to cover you for the rest of your life? I highly doubt it. You know, some people say to me, Look, we've got some money tucked away in our rainy day fund for that reason. Now that's great, that can be used to ties you over short term, but that rainy day fund is there short term to cover unknown expenses that may accrue. What if you are off long term? What if you can never go back to the job that you currently are in and you can no longer enjoy the level of income that you've become accustomed to or you are qualified or experienced to earn? Then all of a sudden that emergency pot is going to be wiped out very, very quickly, particularly if you follow the generalist advice that you should hold around six months of your typical expenditure in a ready access savings account. That's going to be burned through pretty quickly. So then there's the people who say, you know, Benjamin, we've been saving and investing, we've been doing all the great things you talk about. We've got 500 grand in ISAs, we've got 450 grand in pensions. We're going to be okay, we don't need to take out one of these expensive insurance products because we've got enough capital behind us. And I say to them, okay, that might be the case, but this capital was there for another planning reason. It might have been there for a retirement planning pot purpose, it might have been there for a future generation planning purpose, it might be there much longer term to provide you with a bit of security in retirement or to assist with any worries you have around long-term care, later in retirement, whatever it might be. The point I'm trying to make, Money Nerds, is that money was there and it was earmarked for another reason. If that's brought into the financial picture now, then there's going to be some give and take later on in your financial plan. The purpose of one of these insurance products is you can plug the gap in a less costly way and ensure that any wealth you had earmarked for other reasons is preserved for those other reasons. Now, generally speaking, the solid amount of cover you should have here is an income protection plan and a critical illness plan. I'm not going to get into the specifics of both of them today, but generally speaking, the income protection plan is there to replicate your income and pay you the amount of income that you currently earn. But of course, over the course of your life, you would hope to have had salary increases for your earnings to have gone up as you become more and more experienced throughout your working career. Well, the critical illness plan is a lump sum payment which can be used to invest that money to replicate the loss of increase in earnings over the course of your life. So if you can articulate that in a perhaps better way than I already have, is the two products come in income protection will pay out the current level of income you're on. It will subsidize you for the fact that you're no longer learn earning that level of income. But if you think about this, that is paying just a static income for the rest of your working days, potentially. I'll come on to the nuances and intricacies of income protection in a moment. But had you been well, had you been fit, you would have hopefully progressed throughout your career, gone up the pay scale, whatever it looks like to you. You suddenly don't have that privilege anymore because you've almost capped out at the current level of earnings you're on. Well, a critical illness plan can come in with a view to that pot being invested to offset the terminator of wealth. It is inflation to replicate the fact that you're no longer receiving those salary increases. So robust 360-degree cover would involve them both, but we're just covering income protection in this episode of the podcast. So I want to get into the details of that now. And a word of caution is you probably think, you know, this is not going to happen to me, but it does. I have seen this more times in my career than I would have liked. And analysis by Royal London, one of the larger insurers in the UK, they found in 2025 that you have a 23% risk of being off work for two months or more before you are 65. And that's probably higher than you were thinking. One in four of us will be off for an extended length of time. Now many of us will go back to work sooner than that, but some may be off indefinitely. Some may be off and unable to work for the rest of their careers. And if you think about this from the perspective of your financial plan, this is just a horrible cascade of dominoes that you do not want to happen. It can compromise your long-term financial security and that of your family, your children. It is not worth the risk for you to push back on this. We ensure our pets, we ensure our homes, we ensure our cars, some of us ensure our travel. So few of us ensure the greatest asset in our financial plan, which is ourselves. And I think it's just because when we hear hear the phrase income protection, we switch off and we think, oh, I don't need that, that's just a waste of money, isn't it? I really encourage it not to be that case. You should be attaching significance and importance to this. If you're already investing in the stock market, if you're already starting to plan around inheritance tax, and you don't have this bedrock in place, then you're not planning wisely. This is the priority. I'll reiterate that again, money nerds. This is the priority ahead of investing. Have adequate protection in place because if you don't, it's akin to building a financial plan on a two-legged stool. So how does income protection actually work? Well, there's tons of information out there on this. So I'm going to try and relay the most important parts so you can get a solid understanding of where these products fit in. So let's assume that you are currently earning a good amount of income, and something happens in your life, you have a stroke, let's say, that means you are no longer able to do the job that you currently are doing. You're no longer able to earn the high level of income that you currently enjoy because you are in a skilled job and you're rewarded handsomely for all the hard work and studying and effort you've put in over the course of your career. If you do not have income protection, what may happen is you will receive perhaps some sick pay from your employer. They may match your salary for a certain amount of time. You will then go on to statutory sick pay, and that again is limited, and after that, you're pretty much up the creek without a paddle. You have to rely on your personal wealth if you have any, and if you don't, you're going to rely on state benefits, which are not appealing, and certainly not something you should be building long-term financial security on. So where an income protection plan comes in is an insurer steps in to pay you the level of income that you currently enjoy. Now, because you are more likely to have to claim on an income protection plan than you are to claim on, let's say, a life assurance plan, and that makes more sense because you're more likely to have an illness, a stroke, or some kind of accident, which may mean you need to claim on this plan than you are to die. Statistically, you're more likely to have the illness, which of course is a good thing, you don't want to pass away, but what this means is they are more expensive. Now, they are expensive these policies, do not get me wrong, but the point I want to make is if you consider the amount you're spending each month to be a brilliant waste of your money, that really helps to reframe it. And that sounds a bit bonkers, but I say this every month is the money that myself and my wife Hannah spend on protection products, protecting ourselves, protecting future families, it's an amazing waste of money every month. Because if we've wasted that premium that month, it means we are still fit and able to continue working, to continue bringing resources into our financial plan to consider our financial futures for the long term. And if that stops, if we need to claim on these policies, something nasty has happened, and God forbid that'll never happen. But you should reframe this not as a waste of money, but the cost of you being able to maintain financial security in your financial plan. If something does happen that you was unforeseen, then you can continue with the plan. You can stick to the plan. And where income protection works, as I said, is that income gets paid to you typically for the rest of your days until you would have been retired. Now you select the date at which you wish the income protection plan to run to. Often people select an age of let's say 60 or 65 or 67. Typically they may want to run it to state pension age, it varies depending upon your own financial needs and objectives. Of course, the longer you run the plan to, the more costly it will be. So that's a factor to bring in. The other part is you do not necessarily need to ensure the entirety of your income. You may feel that if something nasty was to happen to you, then you do not need the current level of income that you currently enjoy, perhaps because you may be restricted in your ability to enjoy and spend money to the extent that you currently do if something unforeseen was to happen. So you need to think about how much income do you actually want to come in. Again, the gold standard, of course, is to replicate as much of your current income as you can afford to do so, but there is a trade-off there because the premiums will obviously be higher. And often where I start with clients on this is we say how much can you afford to spend every month on these products, and then we work back and try and ensure as much as we can whilst sticking to the budget. So you've got flexibility on how long the product runs for, you've got flexibility on how much it pays you. The other term that you'll commonly come across when looking at these products is what's called the deferred period. And the deferred period basically means when does the policy start kicking in? And the shorter the deferred period, the costlier the policy will be. So generally speaking, these policy deferred periods may be three months, six months, twelve months. And if you think about this in terms of your financial plan, if a deferred period is six months, that means that you will be on your own for six months after you report that illness. And during that window, perhaps you may need to rely on employer sick pay arrangements, statutory sick pay, savings, investments, and at the six-month point, that is when the income protection policy will start to kick in. Naturally, by intuition, if you extend that out to a year, it's going to be less costly because the insurer views that as the likelihood of you getting back to work within that year is greater than if it was six months. And conversely, if you shorten that to three months, there's a greater risk there that the insurer will have to pay out, so the premiums will be higher. So, some of the terminology to be aware of when you're looking at income protection is the term of the plan, the deferred period, and of course the insured amount. So if you had to claim on your income protection plan, let's say in this example, the insured selected a benefit amount of£2,500 a month, a deferred period of three months, and they wanted to run this to age£65 because at that point they assume they will be financially independent. So something happens to them, let's say they have a nasty stroke, the stroke means they can no longer return to their current occupation. So they claim on their income protection plan, and after three months, the policy will start paying them£2.500 every month until they are 65. I would always encourage you to set up these products on an increasing basis. And what I mean by that is every year the premiums will typically go up, but so too will the benefit amounts. Now that effectively gives you protection against the terminator of wealth that is inflation. If you're currently in your early 30s and you're selecting an insured amount of two and a half grand a month, and you do not select increasing cover, then that two and a half grand a month is going to be worth a lot less by the time you're 60 than it is now. So adding in increasing cover will mean an increase in cost every year, but it will all go up with inflation, so it's worth its weight in gold. The point around the two and a half grand a month payout, point number one is that that is tax free, so you will not be taxed on that. But the subtlety and the nuance around this is you can't insure all of your income. Generally speaking, insurers will it varies from insurer to insurer, but they will insure around about 50 to 60, maybe a bit more, of your income. And of course, that will be paid tax-free, whereas generally speaking, your income, as you know, will be subject to income tax. But there's also a kind of human behavioural psyche benefit here or motivation to be more accurate, is of course, if they were to ensure your full income, if you were to be as financially stable as you are had you been earning, there would be no incentive for you to return to work, of course. So there is that trade-off there, is that you cannot effectively be in as comfortable a position as you currently are, but you can still replicate it pretty well when it accounts for the differences between having income tax deducted in the case of your salary or not deducted in the case of the insurance payout. The final point I will make when you look at these income protection plans is there will be different types of plans, and the two you really need to look out for is the idea of an own occupation or an any occupation. So that's own occupation basis or any occupation basis. Now, what this means is what level of incapacity must exist for the insurer to accept the claim. And generally the most watertight insurance is an own occupation because this means that the claim is paid if the insured is unable to perform the duties of their specific occupation. So bringing this to life with let's say a surgeon, let's say she can no longer continue acting as a surgeon because there's been some arthritic development in her hands, let's just say that. Bringing this, you know, hypothetical example. She developed arthritis in her hands, which means she can no longer return to her work as a skilled surgeon. If her policy was set up on the most watertight basis, being an own occupation basis, it would mean that it would pay out because the client is unable to perform her actual job. There would be no requirement to consider alternative work. For instance, she could work perhaps in a less skilled position that you know doesn't need to use her hands in the way that she had done as a surgeon, but that doesn't matter because she's got own occupation basis. So of course that will come with some added cost, but it's worth its weight in gold. I've never recommended the other version of an income protection plan to any client in my life. And that other plan is called any occupation. So in this case, a claim is paid only if the insured is unable to perform any occupation for which they may be suited by education, training, experience. So this is a much stricter claim test. If you think about this from the perspective of the insurer, they're saying, can let's use the woman I used previously, can she perhaps do another job? If her policy had been set up under an any occupation basis, then it's unlikely they would have paid out because although she cannot go back to being a surgeon, she could do something else that may not involve the use of her hands, for example. So an any occupation policy is lower premium, there is a greater likelihood of claim rejection, and it can give a false sense of security. Some people who are driven by price and looking at the premiums of these plans, they may see an any occupation plan as being significantly cheaper, but cheaper is not necessarily best when it comes to income protection. And I would always encourage individuals when you're taking out income protection, you're going to spend a lot on this over the course of your life. So you want to get this right. So seek financial advice on this, folks, whether you're getting this through a regulated financial advisor or a comparison website that directs you to a financial advice professional, getting some advice on this to make sure it's set up in the correct manner. Because if you Don't you could be spending a lot of money under the pretense that you think you're going to be covered when, in fact, you are not. In this case, if this surgeon had taken out this cheap and cheerful any occupation cover, suddenly realized that she no longer can claim on that because she could do another job, and suddenly she no longer can become a surgeon or resume her job as a surgeon, and she also is not going to get anything on an income protection product that perhaps she has paid thousands in premiums over the course of her career. Let's assume she's claiming on this when she's 56 towards the end of her career, by example. You also want to be seeking financial advice on this to make sure you've got an appropriate level of cover. And what I mean by that is if you do not select an appropriate level of insured amount, and if you subsequently have set to claim a greater amount than you're eligible to claim, so for instance, let's say your salary was 50 grand a year, and for some reason, when you set up this product, you overinsured yourself and you set it up to pay you five grand a month, let's say. Well, obviously, that is greater than your level of earnings. The insurer will not say, Hold on, you've been paying for more than you need, we'll refund you the difference. That's not how it works. You potentially could be wasting a lot of money every month paying for cover that you perhaps would never be able to actually claim on, if that makes sense. So do not be skimping on this, is what I would say. And often the case is it's a bit drastic for me to say this, but you either do this or you don't, money nerds. You bury your head in the sand, you don't have income protection in place. Say la vie, that's your cross to bear. I would not recommend it. But if you are going to recognise the incredible benefits these policies have, and that everybody who has someone dependent on their income should have, then you need to be seeking financial advice on this. It's worth its weight in gold for the peace of mind alone. Don't cut corners. As I said there at the end, income protection is almost critical for I say nearly 90% of the people that I advise, certainly pre-retirement, is unless you are an individual who is, let's say, early 20s, has no partner that's dependent on your income, has no children, has no debt, income protection maybe then isn't critical for you, but for anyone else who may have someone dependent on your income, you really need to be considering this. You really need to recognise that you are the greatest risk to your financial plan, and if something untoward happens to you, and by extension your ability to keep earning, to keep paying into your financial plan, the wheels come off and they come off very quickly. Don't be ignorant here. Recognise that the government doesn't have your back, your employer doesn't have your back, you need private protection. And if cost is the barrier to you, you know, I would say to you, it's a great waste of money every month. It's simply, as with any insurance, the cost you pay for financial security. If you're parking a grand a month into your pension at the moment and you're bulking over the prospect of spending£50 a month on an income protection plan, you know, when I see this in clients' financial plans, I just move£50 out of the pension contribution and into an income protection plan. You can afford to do it on paper, we're still putting£950 into your pension, but that£50 going into the income protection plan is a far greater use than an extra£50 going into your pension. And that's even when accounting for the great compounding effect, long-term growth, equity investing, all the great stuff that I talk about endlessly in other weeks of the podcast. That all is pretty irrelevant and not as critical as something like covering your income. So don't underestimate it. If you do not have income protection in place, I highly encourage you, money nerds, to look into this. You're cheaper to insure now than you are tomorrow, so don't delay this. Don't delay till tomorrow what you can start today, is what I always say. So there we go, let's wrap it up. Uh it's been a fairly technical one this week, and I'm conscious it's run on a little longer than I often like with Heads Up on Money, but I hope you've found something of interest there, and I hope it's made you consider and evaluate income protection in a different light. Meantime, have a great week. Goodbye for now.