Protection insurance: who needs what?

If you're looking to protect your family's finances, you might be wondering whether income protection insurance or life insurance will provide the right cover. Laura Starkey explains the differences between the two, and who each form of insurance could be suitable for.

In an era where job security seems uncertain and unemployment is at its highest rate for 12 years, it's no wonder people are concerned about their financial security.

Since the start of the recession, there's been renewed interest from some people in protection insurance policies. However, this comes in many different forms and it isn't always easy to work out which type of insurance is right for you.

IPI v life insurance

A key question many might consider is whether income protection insurance (IPI) or life insurance is the right form of protection for them. During my time as a money journalist, I've heard some pretty heated debates on which form of insurance offers the most useful cover.

In this article, I'll clarify the differences between IPI and life insurance and explain why each form of protection could prove crucial in the event of a crisis. I'll also look at who each form of protection may be suitable for, to help you decide whether one or the other should be your personal priority.

So, what is IPI?

Income protection insurance is a form of cover that's designed to replace a proportion of your income in the event you become incapacitated and are unable to work. This might happen as the result of an accident, illness or injury.

IPI is also known as permanent health insurance (PHI). If you need to make a claim, your IPI provider will pay you a sum of money each month for however long you're out of work - or until you reach retirement age.

For a more detailed explanation of how IPI works and the things you should consider before committing to a policy, read this article.

Who should have IPI?

If you are self employed, it may well be worth taking out an IPI policy. This is because you won't be eligible for sick pay in the same way as an individual employed by a public or private organisation.

Alternatively, it's a good idea to check what sort of sick pay you'd be entitled to in the event you had to take time off from your job. The level of salary you'd receive while ill, and the length of time you'd be paid for, may affect your decision to take out IPI and influence the level of cover you choose.

Whatever kind of work you do, IPI can provide invaluable peace of mind. Having it in place means that your (or your family's) lifestyle could be maintained if you were no longer able to work.

The key thing to note about IPI is that it will pay out while you are still alive, perhaps providing you with an income for many years. As you'll see below, life insurance works very differently.

When it comes to choosing one or the other, IPI may be the right kind of cover for anyone who is worried about how they'd cope if they became too sick to work, but not is so concerned about the financial consequences of dying.

An individual in this situation might have a mortgage and/or other non-mortgage debts which they would struggle to pay if they could not work, but may not have financial dependents who would suffer in the event they passed away.

What about life insurance?

Life insurance is a form of protection insurance that pays out a lump sum upon your death.

To learn more about how it works, read the articles 3 reasons why you need life insurance and 8 useful tips for buying life insurance.

Who should have it?

If there are people in your life who depend upon your income, I think life insurance is a form of protection you should consider putting in place.

Consider: if you suddenly died, how would your husband or wife manage to pay the household bills? Could they afford to care for your children?

If you have a joint mortgage it is crucial that your share of the loan would be covered in the event of your death. Otherwise, your mortgage lender could pursue your partner (or housemate) for the entire outstanding debt.

Likewise, if you have non-mortgage debts, you should ensure these would be covered by a life insurance payout if you passed away. If you don't, they will have to be covered out of your estate - so your family might have to deal with the demands of your creditors immediately after losing you.

Even if you are a stay at home parent with no regular income, you should consider insuring your life. A 2009 study by Legal & General found that it might cost an incredible £32,000 a year to replace the work of a full time mum!

On the other hand, if you have no financial dependents, ask yourself who would benefit from your life insurance payout. While mortgage lenders are always keen to promote life insurance to their customers, this cover is not necessarily appropriate for single or childless homeowners.

In this situation, an IPI policy might seem a more useful form of protection. However, it's important to think carefully about your circumstances and seek advice before making a final decision.

Belts and braces

If you are the main breadwinner for your family, it's easy to see the benefits of having both income protection insurance and life cover. Taking this 'belts and braces' approach means that, if you became too sick to work or suddenly passed away, your loved ones' financial future would be protected.

If you can only afford either IPI or life cover it's up to you to decide which offers better value, taking your personal circumstances into account. For example: if your family would receive death in service benefits from your employer if you died, but you would get very little sick pay should you take a long time off work, you might decide that IPI is more useful.

Before taking out any form of protection insurance, it's vital that you fully understand the terms and conditions of your policy and have a clear idea of what is, and isn't, covered. It's essential to seek proper advice and ensure you buy the cover that's best for you.

Insurance policies like IPI and life insurance may be among the most crucial financial products you ever own - so it's important the money you invest in them works hard for you.

**This material is for information purposes only and should not be considered financial advice. We strongly encourage our readers not to rely solely on this content, but to seek independent advice when making financial decisions.**