Income Replacement

Income replacement is the design purpose of income protection insurance: substituting for lost employment earnings while you cannot work due to illness or injury. It maintains cash flow for mortgages, living expenses, and bills during disability.

The replacement ratio is capped at around 75% of gross income because benefits are taxable. Receiving 75% of gross approximates your normal take-home pay after tax.

What counts toward your insured income

| Income type | Typically included? | |---|---| | Base salary or wages | Yes | | Regular bonuses and commissions | Yes (often averaged over 2-3 years) | | Employer Super Guarantee contributions | Optional add-on (Super Continuance) | | Rental income | Not usually counted as personal exertion income | | Dividends and investment income | Not counted as personal exertion income |

How insurers calculate your sum insured

For PAYG employees, insurers use recent payslips, group certificates, and tax returns. For self-employed applicants and business owners, they typically average gross income less business expenses over the last 2 to 3 years to smooth out fluctuations.

Why the 75% cap exists:

• It reflects the tax treatment (benefits are taxable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997)
• It maintains an incentive to return to work because working income exceeds claim income
• It prevents over-insurance, which would breach the indemnity principle

Income replacement vs lump sum cover

Income replacement is cash flow over time. Lump sum cover (TPD, trauma, life) is capital paid once. The two are complementary: income protection covers ongoing living costs while TPD or trauma cover handles one-off expenses like medical treatment, mortgage payoff, or home modification.