What income protection can and cannot do

Most of us insure the house, the car and the contents, but not the thing that pays for all of it. Income protection is designed to fill that gap. If illness or injury stops you working, the policy pays a monthly benefit — often until you can work again, or until the end of the term you chose.

It is worth being clear about the limits. Individual income protection covers incapacity through accident or illness. It does not normally pay out because you have been made redundant — that is a different risk and, usually, a different product. It also will not replace everything you earn. Insurers typically cap cover at around 50% to 70% of gross income. If you pay the premiums yourself out of taxed income, the benefit is normally paid tax-free, which is why a smaller-sounding figure can go further than you expect.

And do not overlook the state's contribution. Statutory Sick Pay is modest, lasts at most 28 weeks, and has eligibility rules. Universal Credit may help, but the health element involves a work capability assessment and is not designed to keep a mortgage ticking over.

Why the definition of incapacity matters more than the price

The single most important line in any policy is how it defines incapacity. Two policies can cost the same and behave completely differently when you claim. Broadly, you will see three approaches:

• Own occupation — pays if you cannot do your own job. This is the strongest and usually the most expensive definition, and it is the one most people assume they are buying.
• Suited occupation — pays if you cannot do your own job or a reasonable alternative that suits your training and experience.
• Any occupation — pays only if you cannot do any job at all. Cheapest, and the hardest to claim on successfully.

Also check the small print on how your ability to work is assessed. Look for wording about performing the material and substantial duties of your role over your normal working hours. If you work part-time, check the policy pays a proportionate benefit rather than insisting you are fit for full-time work.

Benefit amount, waiting period and payout term

These three settings do most of the work in shaping both your premium and your protection.

• Deferred period — the wait before payments start. Common options are 4, 8, 13, 26 or 52 weeks. Fit this to your employer's sick pay. Many employers pay full pay for a few months and half pay after that, so a 26-week wait could leave a real hole.
• Benefit period — how long the money lasts. Short-term policies pay for one, two or five years. Longer-term policies pay until you return to work, or until a set age such as 65 or your selected retirement age. The longer option costs more, but it covers the scenario that would otherwise wreck your finances.
• Benefit amount — decide the monthly figure deliberately, and include pension contributions if the policy allows. Ask whether the benefit is offset against employer sick pay, state benefits or other cover, because that reduces what actually lands in your account.

Redundancy: a different risk, usually a different policy

Job loss needs a separate plan. Some policies are sold as short-term income protection or redundancy cover, typically paying a percentage of income for 6 to 12 months. They can be useful, but read the conditions carefully: many exclude voluntary redundancy, require a minimum period of continuous employment, and pay nothing for the first 30 or 60 days.

Before buying anything, work out what you would already receive. Statutory redundancy pay is based on age, length of service and weekly pay, and is capped. You may also get notice pay, untaken holiday pay, and support through Universal Credit or new-style Jobseeker's Allowance. Those sources buy time — but rarely enough on their own.

The most reliable redundancy defence is still an emergency fund. Three to six months of essential spending in an easy-access account does more for your peace of mind than most insurance policies, and it covers the gaps insurance will not.

Keeping premiums manageable without gutting the cover

Income protection has a reputation for being expensive, but a lot of that comes from choosing the wrong settings. Sensible ways to bring the cost down:

• Extend the deferred period if you have sick pay or savings to bridge the gap.
• Choose a benefit period that matches the risk you actually fear, rather than automatically going to retirement.
• Consider reviewable premiums (cheaper now, but the insurer can increase them later) versus guaranteed premiums (fixed for the life of the policy). Guaranteed costs more at the start and less in surprises.
• Think about indexation, which increases cover in line with inflation — helpful, but it increases the premium too.
• Never trade away the definition of incapacity to save a few pounds a month. It is the feature you are buying.

Apply while you are healthy. Pre-existing conditions are usually excluded, and full underwriting at the outset gives you far more certainty than a simplified or accident-only policy that looks cheap and pays out narrowly.

A practical way to choose

Start with the numbers, not the brochures. Add up your essential monthly outgoings — mortgage or rent, council tax, utilities, food, transport, childcare, minimum debt payments. Compare that with what you would receive from your employer and the state. The gap is what you are insuring.

Then decide how long you could survive on savings alone, pick a deferred period that fits, and choose the longest benefit period you can comfortably afford. Check the exclusions, the claims process and who decides whether you meet the definition. Finally, review the policy whenever life changes — a pay rise, a new mortgage, a move to self-employment, or a partner stopping work. Self-employed readers should treat this cover as close to essential, because there is no employer sick pay to fall back on.

Buy it for the definition, the payout term and the monthly figure. Everything else is detail.