Income Protection vs Trauma Cover: Which One Should Come First?
Here is a situation I still think about.
A young family. Mum at home with the children, the whole household running on Dad’s salary, a mortgage, not much in savings. They had life cover, trauma cover and health insurance in place. Then Dad got sick and could not work. His doctor told him to take one to two years off.
His illness did not meet any of the definitions in his trauma policy.
So: life cover paid nothing, because he was alive. Trauma paid nothing, because his condition was not on the list. Health insurance paid for his treatment and nothing else. Meanwhile the mortgage, the groceries and the children’s costs carried on exactly as before, and the income stopped for a year or more.
That gap is what income protection exists to fill. It is the cover New Zealanders buy most and my Chinese clients ask about least.
They pay out for two different things
Trauma cover looks at what you have been diagnosed with. If your condition is listed in the policy and meets the definition, you get a lump sum. It does not matter whether you can still work.
Income protection looks at whether you can work. If illness or injury stops you working, then once your wait period is over it pays you monthly, until you can go back to work or until the agreed age.
Six ways they differ
| Trauma cover | Income protection | |
|---|---|---|
| What triggers a claim | A listed condition that meets the policy definition | Illness or injury that stops you working |
| How it pays | One lump sum, yours to spend however you like | Monthly, usually up to 75% of your pre-tax income, or an agreed fixed amount |
| When payments start | On diagnosis, once the definition is met. Major conditions such as cancer, heart attack and stroke have a 90-day stand-down after the cover starts | After the wait period you chose when you applied, commonly anywhere from 4 weeks to 2 years |
| How long it pays | Once | Until you can work again, until the benefit period ends, or until an agreed age such as 65 |
| Relationship with ACC | None | ACC pays 80% of your wages for accidents. Some products offset against ACC and some do not. If illness stops you working, ACC pays nothing and only insurance covers you |
| Tax | Premiums are not deductible, the payout is tax free | The payout is taxed as income and the premiums are deductible. IRD’s principle is that you can only deduct the premium if the payout is taxable |
Three things about income protection people get caught by
Redundancy is not covered. Income protection responds to your health, not to your employer’s decisions. Losing your job does not trigger a claim.
You need to prove your income, both when you apply and when you claim. Pricing also depends on your occupation class.
You cannot buy it without earned income. A stay-at-home parent cannot take out income protection. There is more detail in our FAQ.
So which one first?
I usually suggest income protection first when the household income depends mainly on one salary, there is a mortgage, savings would not stretch for a year, and the job is stable with income that is easy to evidence. Do not underestimate that last point — these applications underwrite smoothly and price sensibly.
I usually suggest trauma cover first when there is no earned income to protect, for example a stay-at-home parent or an older relative close to retirement; when someone is self-employed with income that jumps around and is hard to prove; or when there are already enough savings to absorb a few years. There is one more case: if what worries you most is the one-off cost of the year you get sick — treatment, travel home, family taking time off to look after you — that is a lump sum problem.
Ideally you have both. Keep the trauma sum insured modest and let it deal with the extra costs of the year you are diagnosed, and let income protection carry the long-term cash flow. That is the same principle as deciding who in the family to insure first: protect the person holding the household up.
Keeping the premium manageable
Two settings move an income protection premium more than anything else: the wait period and the benefit period.
If you have three months of savings behind you, a 13-week wait period costs considerably less than a 4-week one. A benefit period to age 65 is the most expensive option; 2 years or 5 years costs much less, but you do need to think through what happens if the illness turns out to be a long one.
For trauma cover on young adults and children, level premiums are worth considering. Once locked in, they do not climb with age.
Premiums have risen sharply over the last couple of years, and the approach in why health insurance premiums keep rising applies here too: restructure before you cancel.
Not sure which one your household needs first, or how much? Send me your income structure, your mortgage and your existing policies and I will work out the gap with you.
Want help working out how income protection and trauma cover should fit together? Get in touch with Cornerstone Insurance.
Phone: +64 211 280 727 Email: amy.tao@cornerstonefs.co.nz WeChat: Amytaoingrace