Income protection for the self-employed

Why the self-employed need it most

Employees usually have a few weeks of paid sick leave and, for work injuries, their state's workers compensation scheme. Most self-employed people have neither. Workers compensation schemes are built around employees, so most sole traders aren't covered unless the rules in their state and the way they are engaged say otherwise. Check with your state regulator if you are unsure.

Moneysmart suggests income protection matters most for people who don't have much paid leave and rely on the income they earn to pay the bills. That describes most sole traders, and it applies twice over if the business has its own costs that keep running while you are off.

How insurers work out a self-employed income

APRA's income-at-risk measure, in force for new policies since 1 October 2021, says benefits should be based on income at the time of claim. Where income is stable, that means annual earnings in the 12 months before the claim. Where income varies, APRA expects the insurer to use average annual earnings over a period appropriate to your occupation. APRA also says income at risk should be based on income from personal exertion, so passive income such as rent, interest or dividends generally doesn't count.

For a sole trader, insurers generally look at what your own work earns after business expenses. For a company director it is usually salary and what the business earns from your work, depending on the policy's definition. The PDS defines income for your situation, and that definition is worth reading before you compare prices.

Evidence at application and at claim

Expect to show income when you apply and again when you claim. Moneysmart lists what insurers ask for at claim time: medical reports and test results, details of your work duties and hours, and payslips and tax returns, or financial statements if you are self-employed. Keep tax returns and financial statements for several years in order, and make sure what you declare to the insurer at application matches what your tax returns will show. A benefit is paid on proven income, not on the figure you picked when you applied.

Choosing a waiting period when you run a business

The waiting period is how long you must be unable to work before payments begin. Moneysmart says most policies offer between 14 days and two years. A longer wait lowers the premium, but only if you could survive it: savings, a partner's income, or work that others in the business can carry for you.

Many policies pay monthly in arrears, which means the first payment can arrive some weeks after the waiting period ends. Check when the first payment would be made and build that into the buffer you plan to rely on.

Business expenses insurance is separate

Income protection replaces your personal income. It doesn't pay the rent on your premises, staff wages or loan repayments of the business. Some insurers sell business expenses insurance for that: it reimburses your share of fixed business costs for a limited period while you can't work. APRA has said its income protection limits aren't aimed at products like this that cover business expenses or loan repayments, so the two are designed and priced differently. If your business carries fixed costs, ask about both and how they interact.

Tax and super for the self-employed

The ATO says premiums for insurance against the loss of your income are deductible, and payments that replace your income must be included in your tax return. If you are a sole trader, ask your registered tax agent where the deduction belongs on your return, because business income and personal deductions are reported in different places.

You can also hold income protection through a super fund you contribute to personally. The premiums then come out of your super rather than your pocket, and you can't deduct them yourself. If you claim a tax deduction for personal super contributions, the overall effect can be similar, but benefit periods in super are often shorter. Weigh the cover, not only the tax.