What contractor income protection does and doesn't cover

Income protection for contractors is the subject of more than just one guide by us.

And rightly so. But, as we know only too well from securing mortgages for contractors, every contractor's situation is unique. A generic guide won't cover every eventuality for every contractor or company director.

So here, exclusively for ContractorUK, I want to isolate a 10 specific usage cases of income protection – and equally important, non-usage cases, so as to pinpoint what contractor income protection does and doesn’t cover, writes Daniel Gibbs, head of protection at Freelancer Financials.

Why contractors need income protection in the first place

When you were a permie (at some stage of your career, surely!?), you would have likely received sick pay if you became too ill to work.

As a contractor, you (technically) employ yourself. So payment for any time off has to come from you, not your client, agency or even (if you’re not a PSC), your umbrella company.

This is what income protection does: it covers a percentage of your income if you are unable to perform your specific job due to an accident or illness.

It's not medical insurance. It's not life insurance. Its sole purpose is to pay your bills when you're unfit for work.

I know that may sound repetitive, but clients get confused, as you'll see courtesy of the (slightly) weird and wonderful example-queries we’ve received below.

1. Does income protection have another name?

Some people refer to income protection as “long-term healthcare”.

But this is misleading, and makes it sound similar to PMI. Income protection is neither.

Private medical insurance covers the cost of surgery or treatment. It will not replace your income during the periods you're having the surgery and/or are convalescing thereafter.

To protect your lifestyle while you're ill or are in recovery, you need a separate income protection policy.

2. Will income protection cover me if I'm abroad?

You need to be a UK resident to take out an income protection policy.

Usually, if you reside in or travel within the EU, USA, Canada, New Zealand, The Isle of Man or the Channel Islands, you can still claim and your policy will pay out with some limitations.

Your policy can still remain in force if you reside in or travel to any other country, but there will be significant limitations to your policy.

If your situation changes and you still want to protect your income, we would recommend that you speak with your adviser.

They can give you all the relevant information specific to your situation. This will help you make an informed decision as to whether it’s worth keeping the policy or looking for something similar, locally.

3. Does my role/industry dictate whether I need to be income protected?

No. Every contractor should have income protection.

Taking out a policy is one of the first things a contractor should do when they start contracting, whether they have a mortgage or not.

If your role has more inherent risk, like an oil and gas contractor, you will pay higher premiums. But even if as an IT contractor coding in an office -- with little apparent risk, you can still be struck ill or have an accident.

4. What are the most common income protection claims?

Related to our answer to Q3, the most common claims on income protection policies are muscular/skeletal, and mental health conditions. Either can happen, no matter what industry you work in.

It's the same as if you've never had a day off in your life or have a repetitive condition. You never know what's around the corner.

If you have a pre-existing condition, you need to be honest about it.

Yes, you might pay a higher premium. But it's better that than not disclosing your condition and your policy being worthless because the insurer might not pay out for a long-term condition you never told them about!

In our experience, the most likely reason an insurer won’t pay a claim is non-disclosure on the application form! You have been warned.

5. Is there any cashback value with income protection? And how much should I set aside for premiums?

Income protection is an insurance policy with no cashback value at all.

You'll only ever receive a payment from the insurer when you make a claim.

With regards to setting an income protection premium budget, there are so many variants it's impossible to say how much your premiums will cost.

Some of the factors that will influence your premiums are:

• how much of your income you want/need to protect;
• your role/industry and its perceived risk;
• your lifestyle;
• any incumbent medical conditions;
• your family history;
• whether it's a ‘personal’ or ‘executive’ policy you need;
• the duration of the policy itself (short-term or ongoing).

That's by no means an exhaustive list. But even from those factors, you can see the scope. The only way you'll know for certain what you need to budget for is by speaking to a contractor-specialist income protection adviser.

6. I'm an umbrella contractor; will my umbrella take out IP on my behalf?

No. The umbrella company will provide admin only. You have no income protection at all by virtue of joining an umbrella.

But on that note, you should take out ‘personal’ income protection through an umbrella, or if you temporarily switch between an umbrella and PSC from assignment-to-assignment.

If you only work through your PSC, then you should take out ‘executive’ income protection. You can cover up to 80% of your salary and dividends, and cover NI and pension contributions on top of this.

You also save monthly by paying from your gross profits instead of from your net income.

Helpfully, your accountant can claim corporation tax relief on the premiums as they qualify as an allowable expense.

7. Can I make my income protection policy dormant if my current contract won't be extended?

No. But, with executive IP, some policies offer you a ‘career break.’

And if you're a company director with executive IP, we can request a ‘career break’ from the provider when your limited company is taking a break.

The policy can stay dormant for up to 12 months, and then be reactivated once you return.

8. I've been diagnosed with clinical depression. Does income protection cover that, and for how long?

Your policy can pay out for any illness or injury so long as it's signed off by a GP or consultant that you are ‘unable to perform’ your job.

If you have depression, the last thing you need is the prospect of your insurer withholding your payouts because you refuse to take a job you are fit for, even if it isn't your pre-existing contract!

You'll receive payouts either until you return to work or until your claim period ends.

9. How do I prove to the income protection provider how long I've been ill?

Send your GP/consultant sign-off letter stating you’re unable to perform your job, to the provider, exactly as you would a ‘sick note’ if you were an employee.

10. Can a provider take back the monies if they find I’m working, or if I’ve just started working following a period of genuine illness where they've paid out?

Yes. They will take back money and probably cancel the policy.

The aim of income protection is to ensure you can maintain your lifestyle but also not leave you in a better-off position than if you were working; otherwise, it would be open to misuse.

If you're receiving sick pay on top of your payout, the insurer will deduct that amount from your payout. That's why they use a ‘deferment period.’

Usually, your sick pay will cover you for a period of time; then the income protection will start paying you the month after your sick pay ends. Your adviser should always take any benefits your employer provides into account before making a recommendation.