Income protection vs critical illness cover for contractors

The rest of the world doesn't stop just because you've become ill or injured yourself, even if you are a very sought-after contractor. You've still got to keep the heating and the lights on. And the postie still pops those bills with your name on through the letterbox no matter what!

But you can prevent illness or injury gobbling up your savings by putting in place protection cover, writes John Yerou, CEO of Freelancer Financials.

There are two main types of protection: income protection and critical illness cover. Here, we look at which is appropriate for you: one, both or neither.

Critical illness cover and income protection aren't the same…

The main difference between critical illness cover and income protection is how you receive the pay-outs.

With critical illness cover, you receive a tax-free lump sum (providing your illness is covered - more on that below). With income protection, you receive a monthly payment, more like a salary.

Also, critical illness pays-out on you being diagnosed with a specific condition to a certain severity. In contrast, income protection pays out for myriad reasons that could keep you from working as long as you have been signed off as unable to continue your specific job by a GP or consultant.

But those are far from the only differences. Let's look at the key points of both to help discern which is right for you.

Income protection for contractors

We've produced an in-depth guide to contractor income protection, so we'll list the key points here, just briefly.

Contractor income protection --

• keeps a regular cashflow coming in while you're unfit for work;
• helps protect the savings and assets you've worked hard to amass;
• allows you to set your level of protected income:

-- up to 65% of your gross annual salary with a personal policy, the benefits of which are paid tax free;

-- up to 80% of your salary and dividends through the company with executive income protection cover;

• is holistic income protection cover, meaning you're part of a support network, not isolated;

-- including considering your mental wellbeing, as well as any physical injury;

• gives you access to:

-- business care (tax advice),

-- doctors' services, and

-- a personal legal advice line.

The above benefits are based on our income protection provider; other insurers' benefits may differ and vary in quality!

The government can potentially support you with a maximum of £109.40 per week for a maximum of 28 weeks; but please note, you cannot get this if you are self-employed.

What does 'fit to work' mean?

‘Own occupation’ is the most suitable definition when thinking of contractor income protection.

With ‘own occupation’ specified, being unfit for work means that you are unable to perform your specific job.

There are other definitions of ‘fit to work’ that give less cover. But they might come with extra conditions, such as having to return to work in a different but suitable role based on your skills, qualifications, and experience.

Or, they may only cover you if you’re unable to do certain daily activities, such as climb the stairs without help. A specialist adviser will ensure that your cover is for ‘own occupation’ (if that’s what you want).

Critical illness cover for contractors

Just as critical illness cover isn't the same as income protection, it's not the same as life insurance, either.

Life insurance pays out when you die, with all the benefit going to your loved ones (or technically speaking, your ‘beneficiaries’). Or, if you have been advised that you have a terminal illness and have less than 12 months to live (this is free ‘terminal illness cover’ within the majority of life insurance policies), you will also receive the pay-out.

A critical illness diagnosis in 2023 no longer means ‘terminal’; far from it. Science and technology today mean you are more likely to survive for many years thereafter. So, when deciding the level of cover, you need to think of supporting yourself as well as those who may have to support you.

We would always advise talking to an experienced adviser at this point. It will add context to the rest of your discussion so that you're clear on exactly what it is you're protecting.

What to look out for in your critical illness policy

No two critical illness policies are alike. How much cover you take/the premiums you pay, will depend on different criteria, including:

• your age, health, and lifestyle, (e.g. do you keep fit, are you a drinker/smoker, and more factors);
• any relevant family medical history;
• who is dependent on you, and what their needs are with the loss of your income;
• the term of the policy, the policy type, and the amount of cover you need/want;
• what you do for a living and its perceived 'risk' to your welfare;
• any hobbies you participate in.

For contractors in particular, an insurance provider may deem the level of risk for an oil and gas contractor to be far greater than for an IT contractor. But who knows; others may deem that office stapler just as threatening!

Killer office supplies aside, ensuring your insurer understands the work you do is another reason contractors should speak about their level of cover to an adviser who understands their day-to-day and their lifestyle.

How much money to have should you survive the diagnosis, but still be unable to work?

You'll receive the pay out after you've had a serious medical condition diagnosis. Different providers cover different medical conditions, so always check the policy to see what's covered before taking it out. This might be critical if you have a history of illness in your family.

The greater amount you cover yourself for, the higher the premiums are likely to be. But don't scrimp. So don't take out a policy, then still find yourself short when the time comes due to the amount of cover or the quality or relevance of your policy.

To get into the right head space, try not to think of your day-to-day as it is now. Your life after diagnosis may differ completely from the life you know today:

• Will you need to stay at home more?
• Will any physical disability impact what work you can do or how long you can work for?
• What alterations would you need to be made to the interior or exterior of your home if you become wheelchair-bound?
• Might you need to pay for a carer for yourself, or a nanny to help with children?
• How much more would heating, electricity and entertainment subscriptions cost you?

We can't predict any of these things with certainty. But we can put in place a brilliant ‘Plan B’ just in case a critical illness strikes. And that Plan B policy starts with a discussion about your 'now' to help protect your future.

The most important thing to take-away as a contractor considering critical illness cover; is this:

It’s not always the amount of benefit you or your family will receive that’s most important. Rather, it’s the likeliness of the policy you have been paying for all these years to actually pay out when you need to rely on it most.

Finally, don’t limit yourself to either/or

There are few (if any) scenarios I can think of where it’s continually a good idea to put all your eggs in one basket!

The same can be said of these insurances: don’t limit yourself to thinking you need either income protection or critical illness cover.

There are many conditions you could potentially be diagnosed with that enable you to claim against both of these policies, should your Plan A get derailed.

If you’re diagnosed with a critical illness, you’re more often likely to be signed off work for 18+ months. There’s nothing to stop you claiming for both income protection and critical illness over this period.

If you had both types of protection, you’d receive the lump sum for being diagnosed with the specified critical illness (from your critical illness policy).

Then, because your consultant has signed you off work while you go through any operations, therapy, and rehabilitation before commencing the road to recovery, you’d also receive the monthly benefit from your income protection policy.

Mental wellbeing plays such an important part in physical recovery. With your bills and expenses covered, you can concentrate on the important thing: getting better. Anything that impedes your progress is an unnecessary barrier; remove the obstacles before they get a chance to stand in your way!