Income protection insurance through super: A definitive guide

When Australians look for savings in the family budget, insurance is often seen as a ‘nice to have’ rather than an essential. Before you hit delete, it’s important to think twice if you have a policy through your super fund.

Many super funds provide members with cost-effective group income protection (IP) cover that can make a big difference to your family if something goes wrong and you are temporarily unable to work due to injury or illness.

Sometimes called salary continuance, IP insurance is a type of life insurance and is often offered by super funds in conjunction with death and total and permanent disability (TPD) cover.

What is income protection insurance?

Income protection cover insures you against the risk of not being able to earn an income for a certain period of time due to illness or an injury. It does not apply to redundancies or if you are stood down.

IP benefits are usually paid monthly as a substitute for your pre-disability earnings. The payments are up to a maximum amount, usually 75% or 85% of your pre-tax income for the period specified in your policy.

Receiving regular IP payments allows you to focus on getting over your illness or injury, rather than having to worry about how to pay your bills.

IP insurance can be particularly important if you are self-employed, have large debts, or have a family or dependents that rely on your income.

Some super funds provide IP insurance cover automatically, others require you to apply for this type of cover.

How does income protection insurance work?

The amount an IP policy will provide if you are injured or become ill is generally either the:

• Indemnity value – A set percentage of your salary prior to your injury or illness.
• Agreed value – An agreed amount selected when signing up.

IP policies inside super are only available with Indemnity value.

The maximum claim amount you can receive through an IP policy is generally 85% of your pre-tax (and pre-disability) salary. This usually includes an amount for super paid directly into your super account, with the remainder of your benefit being paid into your bank account.

The amount shown on your benefit statement is usually the maximum amount you can receive, with the actual amount received calculated by the insurer when you make a claim, based on your earnings in the period before your disability occurred.

If you are receiving income payments from workers’ compensation, paid sick leave, Centrelink benefits or insurance payments, the amount you receive from your IP insurance may be reduced. This depends on the policy terms, which are outlined in your fund’s insurance guide.

The time limit for the period you receive payments if you can’t work (the benefit period), is commonly two years or five years. Some policies continue payments until a specific age – usually 65.

Super funds have different terms and conditions for their IP cover depending on their chosen insurer, but usually you can apply for a policy if you are over age 15. Cover is generally not available inside super after age 65–70.

What does IP cover cost?

Premiums for income protection insurance – particularly outside super – are normally either:

• Stepped – The premium usually rises each time the policy is renewed, as the chance of a claim increases as you get older.
• Level – The premium is higher than stepped cover at the start of the policy but doesn’t increase as you age.

IP cover inside super is usually unit-based and funds generally offer units at a set price per unit.

What you need to know about claims and waiting periods

Most IP policies have a waiting period before you receive a payment, usually 30, 60 or 90 days. The shorter the waiting period, the higher the premium you pay.

No payments are made for the waiting period and, when the insurer accepts your claim, your payments are usually backdated to the end of the waiting period.

To receive an IP payout, you need to satisfy the insurer and trustee that you have met the disablement definition in your policy. You need to be ‘totally disabled’ according to the policy definition, which typically means you need to be:

• Unable to do the important duties of your current job because of an illness or injury; and
• Under the care of a doctor for your illness or injury; and
• Not doing any other form of work.

Making a claim will require you to complete a claim form and provide a statement from a doctor that you are unable to work. You may also need to provide additional medical evidence, such as your medical records, or undertake an assessment with the insurer’s chosen doctor.

If your claim is accepted, regular monthly medical evidence may be requested to ensure you remain eligible for the IP payments.

The insurer may also ask for proof of your pre-disability earnings.

The rules around eligibility for IP payments can be controversial, with some policyholders feeling they have been denied a rightful claim.

According to the Australian Financial Complaints Authority’s (AFCA) 2022–23 Annual Review, income protection was one of the top five super products it received complaints about, with 949 complaints received. Most insurance-related complaints to AFCA involve complex questions about eligibility for cover, delays in claim decisions, avoidance of cover by insurers, and assessment of detailed medical records and other sensitive information.

According to APRA’s most recent statistics, however, in the 12 months to 30 June 2023 group super IP policies had a 97% acceptance rate. Only 3% of group super IP claims were declined across the whole industry, with around 80% of the 19,049 claims finalised within two months.

How much IP cover do I need?

Working out how much IP cover you need is based on your personal circumstances, current earnings and the rules for your fund’s IP policy:

Step 1: Work out your monthly salary

For example, if your salary is $72,000 per year, divide your salary by 12 for a monthly amount ($72,000 / 12 = $6,000 per month).

Step 2: Calculate 85% of your monthly salary

Using the example above, 85% of your monthly salary is $5,100 ($6,000 x 85% = $5,100 per month)

Step 3: Calculate the number of units of cover you need

If your super fund offers a unit of cover for $250, calculate the number of units you need to match 85% of your salary ($5,100 / $250 per unit = 20.4). Round this up to 21 units of cover.

Step 4: Calculate the cost of your cover

For example, your fund’s cover costs $0.2545 per unit for your age if you take a 30-day waiting period, a benefit is paid for two years and you are classified as undertaking non-manual work.

In this example, the cost of your cover would be $5.35 per week ($0.2545 x 21 units).

You would receive 75% of your benefit in your bank account ($3,825 per month before tax) and 10% ($510 per month) would be paid into your super account.

Step 5: Consider your cover options

There are ways to reduce the cost of your IP cover. For example, the $5.35 premium cost would be reduced if you chose to increase your waiting period from 30 days to 90 days. Alternatively, you could choose a shorter benefit period.

The key is to work out how long you and your family could survive without your income if you became ill or injured for a time.

Tax and income protection policies

IP benefits are usually deemed assessable income by the ATO and taxed at your marginal tax rate, regardless of whether you hold your cover inside or outside super.

Generally, the ATO permits you to claim the cost of income protection premiums if they are bought as a standalone policy outside your super fund.

If you pay your premiums inside super using your super contributions, they are not tax deductible.

Do I need IP protection inside super?

Income protection inside super works well for people on tight budgets, those with limited disposable income, or anyone who cannot get IP cover outside super.

IP can provide valuable protection if you have a partner, young family or significant financial commitments. It can help pay the bills or your mortgage for several months while you are off work, which might otherwise be difficult for most families.

Older workers nearing retirement usually have less need for income protection, but this can also apply to part-time workers or those with multiple super accounts.

IP policies inside super tend to have fewer features than policies outside super. Standalone IP policies outside super sometimes offer valuable additional benefits such as accommodation, transport and childcare benefits, home assistance, critical illness benefits, nursing care, elective surgery and counselling support.

If an IP policy inside super doesn’t meet your needs, consider purchasing one outside super with an Agreed value (a set monthly benefit payment) and link the two policies. This can be valuable if you change jobs or have a reduction in your income after taking out your IP policy. By linking the two policies, your claim can be assessed against both the super and non-super policies.