Income protection insurance pays you a monthly amount if illness or injury stops you working. It usually replaces part of your pre-tax income, not all of it. You can hold it through your super fund or in a policy you own yourself, and that choice changes who pays the premiums and how tax works.
How does income protection insurance work?
If you can't work because of illness or injury, income protection usually replaces a set share of your pre-tax income, for example 75% or 90%. The payment is usually based on what you earned in the 12 months before you got sick or hurt.
Every policy has its own definition of disability and its own conditions you have to meet before you can claim. Two features shape how the cover works more than anything else: the waiting period and the benefit period.
Income protection is not the same as life cover or total and permanent disability (TPD) insurance. Those usually pay one lump sum. Income protection pays regular amounts while you can't work.
What is a waiting period?
The waiting period is how long you have to wait before payments start. Most policies offer waiting periods from 14 days up to two years. To get paid, you must still be unable to work because of your illness or injury when the waiting period ends.
The first payment can come later than the end of the waiting period. One large super fund's claim guide says no payments are made during the waiting period, and after it ends payments are made monthly in arrears. So it helps to know how long your savings and leave would last.
What is a benefit period?
The benefit period is how long the monthly payments keep coming if you still can't work. Most policies offer two years, five years, or cover up to a set age such as 65.
The waiting period and benefit period you choose affect the cost of the policy, along with its other features and exclusions.
How are income protection premiums worked out?
Moneysmart says you can usually pay premiums in one of two ways:
- Variable age-stepped premiums. These are based on your age and recalculated each time the policy renews.
- Variable premiums. These cost more at the start, but the price doesn't change because of your age, so increases are generally slower.
Income protection inside super vs outside super
Most super funds automatically give members life cover and TPD insurance if they are 25 or older. Some funds also automatically give income protection. This default cover is for a set amount and you can usually get it without medical checks.
Policies outside super may let you take out more cover and may come with more features. You pay the premiums yourself, but the cost is generally tax deductible.
The table below compares the two.
| Feature | Inside super | Outside super |
|---|---|---|
| Who pays premiums | Taken from your super balance | You, from your own money |
| Personal tax deduction | Not available | Generally available |
| Amount of cover | Often lower | May allow higher cover |
| Effect on retirement savings | Reduces your super balance | Super balance not used |
| Tax on payments | Taxed as income | Taxed as income |
Pros and cons of cover through super
Cover through super can be cheaper because funds buy insurance in bulk. It is also easy to pay, because premiums come out of your super and not your take-home pay.
The downside is that premiums reduce your super. This can matter more as you get close to retirement, because there is less time for your balance to recover. If you have more than one super account, you may be paying for more than one policy and may not be able to claim the full benefit from both.
When super cover can switch off
By law, super funds cancel insurance on accounts that haven't received any contributions for at least 16 months. Some funds also have their own rules and cancel insurance if your balance is too low. Your fund will contact you before your cover ends.
Insurance through super doesn't start automatically if you're a new member under 25 or your balance is under $6,000. You can ask your fund to start it, and some funds give automatic cover to people in dangerous jobs.
To see what you have, you can call your fund, log in to your account or check your annual statement and product disclosure statement (PDS). Moneysmart has more on insurance through super.
Is income protection insurance tax deductible?
For a policy held outside super, generally yes. The ATO says only premiums you pay to protect your income from salary and wages are deductible. This is known as income protection or continuing salary cover.
For a policy inside super, no. The ATO's myTax instructions say you can't claim a deduction for premiums on a policy you took out through your super fund where the fund took the premiums from your super contributions.
Some premiums are never deductible. The ATO lists life insurance, trauma insurance and critical care insurance as policy types whose premiums can't be claimed. You also can't claim any part of a premium that pays for a policy that compensates you for things like physical injury. That matters for bundled policies, where only the income protection part may be claimable.
See the ATO's page on income protection insurance deductions. Our tax return checklist covers other records worth keeping.
Are income protection payments taxed?
Yes. If a policy pays you money to replace your salary and wages, you must include it in your tax return. This applies whether you get regular payments or a lump sum.
Some payers withhold tax and some don't. The ATO explains how to declare income protection insurance payments in either case. If no tax was withheld, you may owe tax when you lodge.
Questions to ask before you compare policies
Moneysmart suggests doing a budget first. It shows your monthly costs and how much income you would need to replace. You might also want to allow for super contributions.
When comparing policies, the main things to check are:
- the waiting period and benefit period
- the share of income the policy pays
- how the policy defines disability
- exclusions, and how premiums may change over time
- whether you already have cover through one or more super funds
The Moneysmart income protection page has a checklist of questions to ask the insurer.
When is it worth getting a professional?
Income protection is a type of life insurance. Anyone giving you personal advice on it must hold an Australian Financial Services (AFS) licence or be authorised by someone who does. ASIC's Financial Advisers Register lists people authorised to give personal advice on life insurance, investments and super. You can search the register to see what products an adviser can advise on.
A licensed insurance broker or adviser can compare policy terms from different insurers. They can also explain how a new policy would sit alongside cover you already have in super, and help with the application. This can be most useful if your health, job or income is complicated, or if you're self-employed.
Advisers may earn commissions on insurance they recommend, and they need your consent to receive them. Moneysmart suggests asking how any commission affects your costs and the advice you get. For tax questions about premiums or payments, a registered tax agent can help.
FIZO lists insurance brokers and shows whether each one is on the regulator's register.