One minute I am flying down Charlotte Pass, congratulating myself on my ability to keep up with my teenage children, the next I am hitting the frozen, unforgiving snow face first – taking the full force of the fall on my chest.
At Cooma District Hospital I have tests, scans, more tests. My back is broken so it’s clear that I am going to be out of action for some time. As a partner in a small financial planning business, this knowledge fills me with dread. How will I earn an income if I’m out of action? How will I keep paying the household bills if I can’t work in my business? Do I have enough income protection insurance to see me through? In other words, how well have I heeded my own advice to protect my single biggest asset… myself?
When we’re asked about our biggest financial assets, most of us list things like the house and car. As a small to medium business owner, you might also list your business – but it’s not the business per se that is your biggest financial asset, it’s you.
Income protection insurance pays you an income if you have an accident or become too sick to work for a period of time. The need for income protection insurance often peaks in mid-life when your debt is high, your dependants are young and your investment balances, such as superannuation, are low. Because as an SME operator you don’t have the luxury of things like paid sick leave, your need for income protection insurance is arguably greater than the need of a salaried employee.
How much do you need?
The rule of thumb is 75 percent of your income. However, if you’re like many SME operators, your income is probably complicated; fluctuating according to your fortunes and including things like the profit you take from the business. It may also be split with your partner. All these things can make calculating the actual cover you need tricky. Advisers who specialise in life risk can help you to calculate your personal exertion earnings to arrive at the appropriate amount of income protection you need.
Because it is sometimes difficult to calculate income, you might want to consider an agreed value policy rather than an indemnity policy. If you opt for an agreed value policy you will have to prove upfront how much you earn per month. This amount becomes the ‘agreed value’ of your income and, should you become unable to work, this is the monthly amount you will receive – no argument. If you opt for an indemnity policy, you won’t have to prove how much you earn when you take out the policy, however you will have to if you make a claim. Businesses do experience ups and downs and the income that you take from your business is likely to reflect those movements. If your income is down at the time you make a claim, the amount you receive from an indemnity policy will also be down. You also need to consider the fact that premiums on agreed value policies are around 20 percent more expensive than premiums on indemnity policies.
What if you need more than you can insure for?
If you are concerned about large debts that will become difficult to service should you fall ill, consider taking out other personal insurances such as trauma insurance and/or total and permanent disability insurance (TPD). Trauma pays a lump sum if you suffer a serious, specified illness or injury while TPD pays a lump sum if you become completely disabled and are unlikely to ever work again.
How much will it cost?
The net cost of premiums will vary according to your occupation, how old you are, your medical history, whether or not you smoke, your waiting period and how many bells and whistles your policy has. As a general rule of thumb, the total net cost of all your personal insurance premiums – including life, trauma, TPD and income protection – will be in the region of one to two percent of your gross annual income.
If you find the premiums a bit of a hurdle, consider opting for a longer waiting period and/or for stepped premiums. Stepped premiums become more expensive the older you get, while level premiums remain the same for the life of the policy. The good news is the government likes income protection insurance because it helps to prevent people going on Centrelink benefits, so premiums are generally tax deductible.
As a postscript – thankfully, I had heeded my own advice well, and my income protection insurance paid me enough money to pay the bills until I could return to work. My hope is that all SME operators have enough insurance to see them through if they suffer a similar experience but that – unlike me – they never need it.
– Greg Cook, CFP is managing director and co-founder of Eureka Financial Group, a leading financial planning practice based in Crows Nest, NSW.