Is income protection through super enough?

Life has a way of surprising us with unexpected challenges. So, if sickness or injury strikes and leaves you unable to work, income protection insurance can act as a financial safety net. It’s designed to provide monthly payments to cover your living expenses during these times, so you’re able to focus on recovery rather than stressing about bills.

While many Australians have income protection cover through their superannuation, the question remains: is this enough to protect your full income?

Choosing between securing income protection through super or opting for a standalone policy can be daunting. With so many variables to consider — like how much cover you need and whether a super-based policy will pay out enough of your pre-disability income — it’s crucial to compare your options.

Below, we have broken down the pros and cons of each option, helping you make an informed decision about what might be best for your situation.

Reasons to secure income protection insurance: comparing your options

Income protection insurance is designed to provide you with monthly payments if you're unable to work due to sickness or injury, and can cover up to 70% of your pre-tax income.

Whether you’re facing upcoming mortgage repayments or navigating day-to-day living expenses, income protection insurance can help you focus on recovery without the added financial stress. In an uncertain economy with rising interest rates and a cost of living crisis, many Australians are finding it harder to manage sudden disruptions to their income. This is where income protection cover comes in handy to maintain financial stability when sickness or injury leaves you unable to work.

So, how do you decide whether to secure income protection cover through your superannuation fund or opt for a standalone policy? Let’s explore your options.

Income protection through superannuation

Most superannuation funds offer income protection policies as part of their default insurance cover. If you're eligible, you're automatically covered unless you opt out. This option is convenient and may be more affordable, as insurance costs would be deducted directly from your super balance, reducing the immediate impact on your take-home pay.

Standalone income protection insurance

Alternatively, you could purchase a standalone income protection policy directly from an insurer. While payments come out of your take-home pay, standalone policies often offer a more comprehensive insurance cover. This includes the ability to tailor the policy to suit your specific needs with things like adjusting the benefit period, waiting period, and how much cover you’d need.

Here are some key considerations to note when comparing options for yourself:

• Cost: Super-based income protection insurance premiums are generally lower, but they can reduce your retirement savings over time. Standalone policies generally come out of your post-tax income, however can offer more flexibility and options.
• Coverage: Standalone policies can often provide broader coverage, including options like longer benefit periods and higher income protection benefits.
• Tax implications: Premiums for standalone income protection insurance are generally tax-deductible, whereas super-based premiums are not. However, income protection claims and benefits received from a super fund may be taxed differently. So it’s always best to speak with a professional advisor.
• Policy definitions: Standalone policies often offer 'own occupation' definitions, which can make claiming easier as you can make a claim even if you can work in a different field outside your current occupation. Compared to the 'any occupation' definitions which is common in super-based policies, as you might have to determine you are unable to return to work in a different role.
• Waiting period: This is the time you must wait after becoming sick or injured before your income protection benefits start paying out.

What are the benefits of income protection through super?

Income protection through super has several benefits that make it an attractive option for many Australians, including:

• Cost-effective: Since the premiums are deducted from your superannuation balance, there's often no immediate impact on your cash flow with this option. This can be particularly beneficial if you're on a tight budget or have other financial commitments. Additionally, making an income protection claim through your super fund is often straightforward and simplified, as most funds include default cover.
• Replaces your pre-disability income: Income protection through super typically provides a portion of your pre-disability income as a monthly income protection benefit. This could help you cover essential expenses if you're unable to work due to sickness or injury as you’ll still have a steady stream of income during challenging times, often anywhere from 70% to 90% of your regular earnings, depending on the policy you select.
• Convenient and accessible: Super funds often provide default income protection cover without requiring a medical assessment at the time of joining the fund, which may make it easier for members to secure coverage. This is especially valuable if you're unsure about how much cover you need or have pre-existing health conditions that might make getting standalone insurance more challenging.
• Simplified management: Having your income protection cover within your super fund means fewer accounts and policies to manage. Everything is in one place, which can simplify your financial life and reduce the administrative burden.

What are the drawbacks of income protection through super?

Despite its advantages, income protection through super also comes with several potential drawbacks that you should consider before deciding if it's the right option for you.

• Reduced retirement savings: While the cost of premiums may not impact your immediate cash flow, they can reduce your superannuation balance over time as premiums are generally taken out of your super. This can mean less money for your retirement, potentially impacting your financial security in later years.
• Limited coverage: Default income protection insurance through super is often more basic, with lower benefit limits and shorter benefit periods. If you need a higher level of coverage, you might find that the default option doesn't meet your needs, and upgrading through your super fund may not be as flexible as a standalone policy.
• Tax implications: Income protection benefits paid through super are subject to different tax rules compared to standalone policies. For example, if you receive income protection payments from your super fund, these may be taxed as normal income, reducing the overall benefit you receive.
• Restrictions on claiming: Some super funds have stricter eligibility criteria and may impose limitations on when and how you can claim. For example, you might only be able to claim if you're permanently unable to work in your usual occupation, which might not be the case with a standalone policy.

How to claim income protection on your tax return

When you have a standalone income protection policy, the premiums you pay are generally tax-deductible, providing a financial incentive to choose this type of cover. Here are some tips on how you can claim income protection insurance on your tax return, and ensure you speak with a professional financial advisor:

1. Determine the deductible amount: The premiums paid for income protection insurance that covers the loss of income are tax-deductible. However, if your policy includes additional benefits like a lump sum payment on permanent disability or cover for other injuries or sicknesses, the portion of the premium that covers these extras is generally not deductible.
2. Keep records: Keep detailed records of all premium payments throughout the year. This documentation will be required when you lodge your tax return.
3. Lodge your claim: When lodging your tax return, include the deductible amount under the appropriate section. If you're unsure how to do this, you should consult with a tax professional.
4. Claiming for super-based income protection insurance: It's important to note that these are generally not tax-deductible. However, the income protection benefits you receive from a super-based policy may be taxed differently, which could affect your net income during a claim period.

It's recommended to regularly review your income protection coverage, especially after major life changes like starting a family, changing jobs, or taking on new financial commitments. So that your coverage remains adequate for your evolving needs.

Income protection through super can be a cost-effective and convenient option, but it’s essential to weigh the benefits against the potential drawbacks. While it may provide adequate coverage for some, others might find that standalone income protection policies offer greater flexibility and broader coverage to hopefully align with the income protection you need.

Keep reading: Learn more with our guide to income protection for sole traders.

Understanding the tax implications and the impact on your retirement savings will help you make a more informed decision, so be sure to speak with a professional financial advisor. Ultimately, the right choice depends on your individual circumstances, financial goals, and how much cover you require to feel secure. Find the right income protection insurance for your needs and request your quote online now.