Going out on your own and being your own boss brings with it many benefits – but a backup plan in case you get too ill or injured to work is not one of them. Contracting means giving up the perks that come with being employed, like financial protection in case you get sick (or worse).
Not to worry: there is insurance that can help you put your own plan in place. As a contractor, it’s important to consider what the impact of illness or injury would be in your circumstances. That way you can weigh up whether or not you need to take out protection and, if so, what kind of cover is best for you.
What is income protection?
Income protection is an insurance policy that pays out a monthly amount if you’re unable to work for health reasons. It’s there to make sure you’ve always got an income, even if you’re too ill or injured to work for a long time.
This kind of cover can be particularly important and valuable for people who don’t have sick pay, like contractors. Not having sick pay could make you more financially vulnerable if you can’t work for health reasons. The consequences might hit you sooner or harder than they would for someone who does have the backup of sick pay.
Income protection can be peace of mind that you’ll always have a monthly income, even if you can’t work. In other words: peace of mind that you’ll always be able to keep up with your financial commitments and keep supporting any financial dependents you may have.
Do contractors need income protection?
As a contractor or director of a limited company, having income protection in place can be an important way to protect your finances in case of ill health. To work out whether or not you really need income protection, consider how you would cope financially without an income. How long could you keep up with the cost of life? What could the long-term financial consequences be if you became too ill to work for a long time?
Since contractors don’t have sick pay through an employer, most contractors have a need for income protection. This is because most working adults, especially directors of limited companies, would face financial consequences if an illness or injury caused loss of income (especially if it was long-term).
How does income protection for contractors work?
Insurers will typically cover contractors for 50-70% of your income with income protection insurance, depending whether you take out the cover personally or through your limited company. This means the policy would pay out a monthly income of this amount if you need to claim because you’re unable to work for health reasons.
All income protection policies come with a waiting period of a set number of weeks. You choose this based on how quickly you’d need the policy to start paying out if you lost your income (depending what other financial backup you have if you find yourself in this position). Generally speaking, the longer the waiting period, the cheaper the monthly insurance premiums, and vice versa.
You can also choose between short-term and full-term income protection insurance. A short-term policy covers you up to a maximum payment period per claim (usually 1, 2 or 5 years), while a full-term policy would cover you for as long as you need it to per claim (usually until a maximum of retirement).
Who pays for contractors income protection?
As a contractor, you can choose to pay for income protection personally or via your limited company. If your company owns the policy, it’s known as an ‘executive’ income protection policy. When it comes to paying for and claiming on an income protection policy, each approach has its own tax implications.
If you pay for an income protection policy yourself, you’ll do so using post-tax income; but if you pay via your limited company, it’ll be deemed an allowable business expense and therefore be tax-deductible. However, if you make a claim on a personal income protection policy, you won’t have to pay tax on the monthly benefit you receive; but if your income protection policy is paid for by your limited company, the monthly benefit will be subject to tax.
It’s also worth bearing in mind that since an executive income protection policy is owned by the company, it would be voided if your company ceases to exist. This wouldn’t happen if you took out a personal income protection policy; this would remain in place to protect you even if you liquidate your company.
What to consider when buying income protection as a contractor
- What length of time insurers use to calculate your average monthly income (some insurers use a longer period of time to calculate this than others – e.g. 3 years – which may be preferable for contractors as it ensures your insured income is less volatile)
- What length of time insurers use to calculate your average monthly dividends (some insurers use a longer period of time to calculate this than others – e.g. 3 years – which may be preferable for contractors as it ensures your insured income is less volatile)
- Whether the insurer allows you to include additional business expenses as part of your insured income (this may be important if you receive non-monetary benefits like a company car that could be included)
- Whether the insurer allows you to include dividends paid to your spouse as part of your insured income (this may be important if your spouse is a director of your limited company and receives dividends through it)
Top tips when buying income protection as a contractor
- Get a policy with a minimum benefit guarantee
This means the amount paid out each month if you need to claim will never fall below an agreed amount. If you don’t have this guarantee, the amount paid out could fall if your income falls – which can easily happen from time to time if you’re contracting. A minimum benefit guarantee means you’ll always have a good level of protection even if your income fluctuates.
- Get a policy without minimum hours restrictions
Some income protection policies require you to have been working a minimum number of hours per week for you to be considered ‘employed’. The insurer might not pay out if you don’t meet the minimum number of hours. Again, this could be problematic for contractors as working patterns can fluctuate – so it’s best to look for a policy without these restrictions.
- Get a policy that doesn’t penalise you harshly if you’re between contracts when you become ill or injured and need to claim
Look for a policy that will still pay out in the same way if you’re not working when you become ill or injured. Some policies will make allowances for this for up to a year, making no changes to the way your claim is assessed. Again, this is of particular use to people who may be between contracts at the point of needing to claim on their income protection.