Income protection: insuring the pay cheque

It's a strange habit: the car is comprehensively covered, the phone has its own policy, and the income that pays for both runs bare. Income protection insurance covers the earner — per Moneysmart's guidance, it usually replaces a percentage of your pre-tax income if illness or injury stops you working, paid as monthly income rather than a one-off. Super funds often badge the same product salary continuance: a regular income for a set time when you can't work.

Its nearest neighbour is TPD — total and permanent disability insurance, which pays a single lump sum if illness or injury leaves you permanently unable to work again. The two solve different problems: income protection is a stream for the months or years work is interrupted, while TPD is one payment for the case where it never resumes, meant for things like living costs, medical and rehabilitation bills, home modifications and clearing debt. Plenty of people hold both, often through super, without a clear picture of which does what.

Both covers are real but conditional. Each income protection policy has its own definition of the disability that triggers it and its own conditions, and exclusions vary — Moneysmart's examples include self-inflicted injury, something illegal you've done and active military service, with possible limits around pre-existing conditions. In other words, the definitions section is the product: two policies with the same name on the cover can pay very differently in the same bad year.

The first dial is the waiting period — the stretch between stopping work and the payments starting. To be eligible, Moneysmart notes, you must still be unable to work because of the illness or injury at the end of that wait. The options on offer run from weeks out to years, and the choice is a genuine trade: every week you can carry yourself is a week of any claim the insurer never has to fund.

The second is the benefit period — how long the monthly payments keep coming if you remain unable to work: a set number of years, or through to a set age. The third is the portion itself: cover usually replaces a share of your pre-tax income, not the lot, and the exact share lives in the policy schedule rather than in your assumptions. Between them, these three dials decide how much claim you're actually buying — which is what a premium prices.

The last dial is how the premium is built. Moneysmart describes two structures: variable age-stepped premiums, based on your age and recalculated at each policy renewal — so the price climbs as you age — and variable premiums, which charge more at the start but whose increases aren't age-based and generally arrive more slowly. Where the policy lives changes the tax, too: hold it outside super and you pay the premiums out of your own pocket, but Moneysmart notes the cost is generally a tax deduction — while any payment received under an income protection policy must be included in your tax return.

There's a fair chance you hold some of this already. Most super funds offer default income protection — cover the fund gives members automatically, without being asked — and Moneysmart's first suggestion is to check whether you already have it before buying more. Premiums are deducted from your super balance rather than your take-home pay: painless on cash flow, but it reduces your retirement savings over time. Bought in bulk by the fund, the cover can also be cheaper, and may be available without medical checks. The whole arrangement has its own page: Insurance in super.

Same name, different products, though. Default amounts may not match what you actually need, while Moneysmart notes policies outside super might allow a higher amount of cover, with more features and benefits available. Definitions can shift with the address too — on the TPD side, the easier-to-claim own-occupation definition (unable to work again in the job you had before) is typically only available outside super. The relationship differs as well: inside super the fund provides the cover and its details live in the product disclosure statement and your annual statement; outside it, the policy is one you bought and pay for yourself.

The exits matter most. By law, super funds cancel insurance on accounts that go without contributions for long enough — the law fixes the exact stretch, and Moneysmart's insurance-through-super guidance carries the current rules — and cover can also end when a balance falls too low or an age limit is reached. Hold two funds and you may be paying premiums on more than one policy, eroding both balances. So check the cover before changing funds or closing an account — Moneysmart's own pre-purchase questions include what happens if your account goes inactive, and whether changing jobs changes the cover.

Moneysmart's sizing method starts with a budget, not a salary: work out the monthly expenses that would keep arriving if the pay stopped, decide whether to count your super contributions in, then tally everything that could already carry you — savings, other cover, support from family. The gap between what you have and what you'll need is its guide to how much cover to get. Notice what the method doesn't start from: your gross income. The mortgage and the groceries don't care what you used to earn — the essential outgoings are the thing being insured.

It also puts your buffer to work. Sick leave, annual leave and an emergency fund are, in effect, a self-insured waiting period: however many months they'd cover the essentials is a stretch no insurer needs to pay for. That's the link between the buffer and the dials — the more months you already own, the longer the waiting period you can afford to choose, and the less of the claim you're buying from the insurer at all.

None of these are set-and-forget numbers. A new mortgage, a new dependant or a changed income moves the essentials, and with them the budget that sized the cover — so the gap is worth re-running whenever life changes shape. The final fitting is licensed work: Moneysmart's own guidance is that if you need help deciding whether you need income protection and how much, speak to a financial adviser — someone who can also read a policy's definitions closely enough to know how it would pay.