Life insurance or income protection: what each pays for

Income protection is not a type of life insurance. They are two separate products that pay out for two different things. Life insurance pays a lump sum when you die, and usually only then. Income protection pays a regular monthly income if you cannot work because of illness or injury, and it does not normally pay out on death at all¹.

The confusion is common because both sit under the same umbrella of protection insurance, alongside critical illness cover¹. But the trigger, the shape of the payout and the job each one does are different. Life insurance replaces a person's earning power for the people left behind. Income protection replaces part of your own income while you are still alive but unable to earn.

The practical difference shows up in the numbers. Income protection typically pays around 50% to 70% of your salary, and some policies quote up to 65% of your wage³. It starts after a waiting period you choose, usually 4, 13, 26 or 52 weeks, and continues until you return to work, retire or the policy ends⁵. Life insurance pays once, as a lump sum, on death².

Income protection is not a type of life insurance

The two products are built around different events. Income protection is designed to replace some of your income if you cannot work because of illness or injury⁵. It pays a percentage of your income each month, and it is also known as permanent health insurance². Life insurance, by contrast, only pays out when you die, as a lump sum⁸.

Income protection is not the same as loan protection or payment protection insurance either. Those usually provide only short term benefits, whereas income protection is built to pay for as long as your inability to work lasts². It is also not a savings or investment product: it will only pay out if a valid claim is made¹¹.

One thing income protection does not cover is redundancy. It only covers you if you are unable to work because of illness or accidental injury, not because you have lost your job⁶. If you want cover for not being able to work, income protection is the product; if you want cover for being out of work, that is a different kind of policy.

Life insurance is not a legal requirement in the UK, unlike car insurance¹³. Neither product is compulsory, and both are chosen to cover a risk a person decides they want to protect against.

What each one pays out and when

Income protection pays a regular income, normally monthly in arrears, starting in the month after the deferred period has expired⁵. Payments continue until you return to work, retire, the policy term ends or you die⁵. Some policies pay out until you can go back to work or reach retirement⁸. Claims are typically paid until the person returns to work, retires or the policy ends⁶.

Life insurance pays a single lump sum on death. Some policies also pay out early if you are diagnosed with a terminal illness and are expected to die within 12 months, though not all policies include this benefit¹⁵. A cancer diagnosis on its own does not trigger a life insurance payout, because life insurance usually pays out only when you die¹⁷.

There is a middle product worth knowing about. Family income benefit is a type of term life insurance that pays a monthly salary rather than a lump sum when someone dies, running from the death until the end of the policy term¹⁴. If death happens after the term ends, there is no payout¹⁴.

How much income protection pays: usually 50% to 70% of earnings

The headline figure most sources give is a proportion of your earnings before you were unable to work. One insurer states the amount you get when you claim will be limited to between 50% and 75% of your earnings before you were unable to work⁵. Independent reporting puts it at around 50% to 70% of your salary³, and consumer guidance says you can expect about a half to two-thirds of your earnings before tax from your normal job².

Some insurers quote higher ceilings. One product page says you will receive a percentage of your income, usually up to 65% of your wage⁴. Another insurer's guidance says income protection usually covers around 80% of your pre-tax salary¹⁸. These are the insurer's own figures for its own products, and the range across the market is wide.

The reason payouts are capped below your full income is to prevent over-insurance. You cannot insure yourself for an amount higher than your earnings when you take the policy out⁵. If you have more than one income protection policy, the total you can claim is usually capped at a percentage of your pre-disability income across all policies¹⁹.

There is also a partial return rule. If you go back to work on reduced earnings, the policy can top you up. If you are earning 60% of what you were making, for example, 40% of your income protection benefit would be payable until your earnings reach their previous level⁵. Some policies also pay a rehabilitation benefit for up to six months after you return to work⁵.

The deferred period: 4, 13, 26 or 52 weeks

The deferred period is the amount of time you have to have been off work before the policy will start paying you benefit, agreed when you took out the policy². It is the waiting period before payments begin, and it is one of the main choices you make when setting up cover.

The common options are four, 13, 26 or 52 weeks⁵. Some insurers also offer 8 weeks, giving a choice of 4, 8, 13, 26 or 52 weeks²⁰. Typically the default deferral period is 13 or 26 weeks, but it can be as short as four weeks²². Across the market the deferral period can generally range from one to 12 months after you were taken ill, with longer waiting periods often reducing the cost²².

Longer deferred periods usually mean lower premiums, because the insurer expects to pay out for less time⁵. The trade-off is that you need savings or sick pay to bridge the gap. If your employer pays full sick pay for six months, a 26-week deferred period may line up with that; if you have no sick pay, a shorter period means money starts sooner but costs more.

There is a condition to watch. If you have been unemployed for more than 12 months when you first become incapacitated, or you take a career break, a 13-week deferred period can replace the shorter period you selected²³. Claim notification deadlines also vary by deferred period:

What each costs and what changes the premium

There is no fixed price for either product. Life insurance premiums are based on your age, health and lifestyle⁸. Income protection costs are affected by your age, your health, your job, hobbies and lifestyle, the waiting period, and whether you might be prepared to do other kinds of work than your own².

Income protection is medically underwritten when taken out, but the premiums are then either set and fixed or rise each year by a specified amount⁶. Premiums can stay fixed, increase by a fixed amount each year, or rise by a variable amount linked to an index such as the Retail Price Index or National Average Earnings Index⁵. On renewable policies, which cover a five or ten year period, the premiums go up to reflect your age at the start of the new policy, and you take out a new policy at the end of that time without providing additional health information⁵.

Income protection tends to be more expensive than mortgage payment protection insurance⁸. Prices vary depending on your job, health and the level of cover, and cheaper policies may offer a lower level of protection, so it is worth checking what is included³.

For life insurance, family income benefit policies offer guaranteed premiums, fixed for the whole term, or reviewable premiums, which may cost less initially but can be increased on regular review²⁵. Applying indexation generally does not change the starting premium, though some insurers may apply a slight increase, especially for income protection²⁶.

Where each policy will not pay out

Income protection has a list of exclusions. You will not receive benefits for accidents or illnesses caused by:

• drug or alcohol abuse⁵
• criminal acts⁵
• intentional self-harm⁵
• wars⁵
• pregnancy, unless your policy includes it⁵

It will not normally pay out if you are unemployed when you become unable to work, though if it does, it will be based on your ability to perform certain activities of daily living⁵. Your policy may only be valid while you are resident in the UK, EU or Western Europe, USA or other developed countries⁵.

The definition of incapacity matters enormously. Some policies will only pay out if you cannot do your specific job, while others may consider whether you could do a different type of work³. The most common definitions mean you would not be able to:

• work in your current occupation⁵
• work in any occupation you are trained for or have experience in⁵
• work in any occupation at all⁵
• do various daily activities like dressing, washing, eating, climbing stairs, shopping or cooking⁵

Life insurance has its own limits. If you do not die during the term of a term policy, the policy does not pay out the death benefit and the premiums you have paid are not returned²⁷. Insurers are legally entitled to refuse cover where the medical prognosis is that you will die during the policy term¹⁷. People who have recovered from cancer may be asked for detailed medical information and to attend a medical examination, with higher premiums and restrictions on the maximum sum insured¹⁷.

Health, smoking and disclosure when you apply

Both products depend on you answering questions honestly. For income protection, you must give your insurer full details of you and your family's medical history, plus dangerous hobbies or a lifestyle that includes smoking, heavy drinking or drug taking². For life insurance, you must tell your insurer if you smoke or vape using nicotine products, even if you do so only occasionally¹⁶.

Insurers weight premiums for people who use vapes, gum and patches the same as for those who smoke cigarettes¹⁶. If you lie about your smoking and get a cheaper premium as a result, you will have committed fraud, and your policy may be declared void and any payout refused when your family claims¹⁷.

Applications typically ask for your age, occupation, smoker status, height and weight, medical history, alcohol consumption, travel and residency, and hobbies such as hazardous activities²⁹. You will also be asked about any family illnesses, and your acceptance terms may be affected by the nature of the condition²⁹. If you do not tell the insurer full and accurate information about your health when applying, any future claim may not be paid²⁹.

Once a policy is in place, the position changes. If you already have life insurance and are subsequently diagnosed with diabetes, you do not have to tell your insurer or pay higher premiums¹⁵. Once a policy is in place, the premiums cannot be increased after a cancer diagnosis, and the policy cannot be cancelled as long as you make full and honest disclosures and continue paying premiums¹⁷.

Having both: how they fit together

The two products cover different risks, so holding both is a common arrangement. Life insurance protects the people who depend on your income if you die. Income protection protects your own income if you cannot work. Neither replaces the other.

If you have a joint mortgage, both of you would typically need life insurance, either jointly or separately⁸. Joint life insurance is a policy taken out by two people, typically a couple, that pays out upon the death of the first policyholder, then the policy ends and does not cover the surviving partner¹⁴. The main disadvantage is that you get only the single payment per policy, even if both policyholders die during the term¹⁴. You can have a joint life insurance policy and a single life insurance policy at the same time¹².

Income protection is generally a single life plan, so joint income protection is not the norm²⁰. If you have more than one occupation, the income from all of them will be taken into account to calculate the benefit payable²³.

Where state support fits in matters too. Insurers consider state benefits you might be able to claim, such as Statutory Sick Pay, Universal Credit or Employment Support Allowance, when working out what the policy pays⁵. Statutory Sick Pay is treated as earned income, so you pay income tax and Class 1 National Insurance on it³⁰. If you have an income protection plan, income from your pension could reduce payments from the plan, so it is worth checking with your HR or pensions department³¹.

Tax on the money you receive

Income protection benefits are paid tax free⁵. Life insurance payouts are not subject to income tax or capital gains tax¹⁰. There is also no Insurance Premium Tax on life insurance and income protection insurance⁹.

Inheritance tax is the exception to watch. Life insurance does not incur tax, but the payout would be added to the value of your estate and may then be subject to inheritance tax¹². Life insurance payments are not taxed, but may be added to the value of your estate and subject to inheritance tax unless the policy is written in trust¹³. Writing a policy in trust is the step that keeps the payout outside the estate.

If you stop paying, and where to get help

If you stop paying premiums, you lose your cover⁵. With income protection, your cover will stop, your policy will end, and you will receive no benefit¹⁹. With life insurance, if you stop paying or cancel the policy, the plan will end and you will get nothing back¹⁸. Over 50s life insurance works the same way: you must pay the premium until you die, and if you stop paying, your entire policy is cancelled and you get nothing back¹³.

Neither product can be cashed in. You cannot cash in or surrender an income protection policy, and they do not normally pay out on death⁵. Life insurance usually pays out only when you die¹⁶.

If something goes wrong with a claim or a policy, the Financial Ombudsman Service handles complaints about income protection and other medical insurance². Free, impartial guidance on protection insurance and on what cover might suit your circumstances is available from MoneyHelper.