According to Which: “income protection is an insurance policy that pays out if you’re unable to work because of injury or illness”.
In my “Back Yourself – Part 1” post I covered different types insurance policies out there and concluded that the must-haves are:
Life insurance – if you have any debt.
Income protection – if you work and do not have passive streams of income to exceed your monthly expenses.
Now, with income protection you decide when you want the insurance company to start paying you each month once you fall sick (either physically and/or mentally).
This is known as the deferment period.
Each provider varies but it can be as soon as 1 week to as long as over 6 months – it is up to you.
The longer you wait to have them pay you; the cheaper it is.
The reason being that the longer you wait to get paid, the higher chance that you will recover and not need to claim anything.
What should my deferment period be?
This is where your knowledge (or lack thereof) about how much you spend each month will be exposed.
How much do you spend each month?
What proportion of that expenditure is necessary expenses?
My post on budgeting will really help you out here.
I have provided a free template that you can populate with your own figures about what is entering and exiting your bank account per month.
To help you work out how long you can afford your deferment period to be (and in my humble opinion, the longer the better) then you need to know your number.
“Your number” is effectively the total sum of your baseline expenses.
That will include monthly liabilities that you HAVE to pay each month in order to get by – i.e. rent, mortgage payments, bills, direct debits, standing orders, loans, food and petrol etc.
Once you know how much leaves your account to pay for those necessary expenses each month then you can calculate how much you need to save up in your emergency fund.
Financial advisers will all say have at LEAST 3 months worth of your baseline expenses as a safety net – a buffer.
If you work out that your essential outgoings equate to £1000 / pcm (per calendar month)
Then your emergency fund should be – as a minimum – £1000 x 3 months = £3000.
That money should then be placed into a savings account, which I mention in this blog post, and not ever touched or withdrawn upon unless it is an emergency.
It is an emergency fund after all!
So, you now have your emergency fund of £3000.
Which means that if you fell ill and could not work and your employer eventually stopped paying you then you would have 3 months worth of savings to fall back on.
You would have to, of course, live frugally to ensure that your emergency fund paid off your monthly necessary expenses for 3 solid months but you would be ok.
Now, at that 3 month mark you might find your emergency fund has run out but do not panic!
Your income protection provider now has to step up and start paying you – phew!
The insurance company will keep paying you that agreed monthly sum (between 60-85% of your salary) until you either get better or retire.
To me it is simply a no-brainer but so few do it, which is crazy, given so many go off sick and then get into financial trouble because they have no savings.
This is why I do this blog because then I can make a few more people aware of the importance of insuring yourself; your greatest asset.
I have used £1000 baseline expenses and 3-month deferment period as an example but it does vary person to person so make sure you do your own math based on your own budget spreadsheet.
People always overestimate how much they have and underestimate how much they spend.
So, in summary:
Do the sums.
Work out your baseline expenses amount.
Multiply it by x3 (ideally x6) to save up an adequate emergency fund.
Delay your deferment period for as long as you can (based upon how much you have in your emergency fund).
Then go and cancel your mindfulness membership because if you implement the above, you’ll be chilled af.
Pensions! Woop woop! Bet you cannot wait.
You can get endorphins from the sun so spending a little bit of time outside can do wonders for your mood.
This blog is for educational purposes only and should not be construed as financial advice. It is purely opinion-based.