Income Protection Insurance & Annual Leave Accumulation

At a glance

• Annual leave and income protection operate under separate rules, affecting accrual, payment timing and income assessment during incapacity.
• You can request annual leave at any time under employment law, but income protection will not usually be payable for the same period.
• Annual leave accrues only during paid leave and some protected absences, and does not continue during income protection claims, as these periods are treated as unpaid leave.
• Taking annual leave usually suspends income protection payments, so many employees retain it for better use.
• Individual outcomes also depend on policy terms and workplace arrangements.

 

 

Income protection insurance provides income replacement when a worker is unable to perform their duties due to illness or injury. These benefits are paid under the terms of the policy and operate separately from employment entitlements such as annual leave.

Uncertainty often arises about whether annual leave continues to accrue during a claim or whether annual leave payments and income protection benefits can be paid for the same period. This uncertainty reflects the relationship between the Fair Work Act 2009, which governs leave entitlements, and the offset provisions commonly applied in income protection policies.

Taking annual leave during a claim without understanding how it is treated under the policy can lead to reduced benefits, payment corrections, or complications during assessment. The following sections outline how leave entitlements under employment law and the policy conditions of income protection apply during a claim period.

 

 

 

Can You Be Paid Annual Leave While Receiving Income Protection Insurance?

 

Yes. In most cases, annual leave entitlement can be requested at any time under Australian employment law; however, income protection benefits will not usually be payable for any period in which annual leave is taken.

While the Fair Work Act 2009 permits access to accrued annual leave, income protection benefits are determined by the policy conditions. Most policies include offset or “other income” provisions that prevent benefit payments when employer-paid leave is received for the same period.

From a legal perspective, the entitlement to take annual leave remains intact. Under the policy conditions, however, annual leave payments are treated as income for the relevant period and generally reduce the income protection benefit to zero or suspend payments until the leave ends.

As a result, the statutory entitlement to annual leave is unaffected, but taking annual leave during an active income protection claim typically stops income protection payments for that period.

Understanding these limitations requires recognising the distinct purposes and conditions that govern annual leave and income protection. 

 

 

Difference Between Annual Leave and Income Protection Insurance

 

Annual leave and income protection operate under separate systems and serve different purposes.

Annual leave is an entitlement under the Fair Work Act 2009 that provides paid time away from work and accrues progressively based on ordinary hours of service. The employer pays it and forms part of the overall employment relationship.

Income protection is a contractual benefit that replaces income when a worker is unable to perform their duties because of illness or injury. It is assessed and paid in accordance with the policy conditions, which determine the benefit amount, waiting period, and treatment of any employer-paid income during the claim.

Key Differences of Annual Leave vs Income Protection Insurance

Feature	Annual Leave	Income Protection
Source of entitlement	Statutory entitlement under the Fair Work Act 2009	Private insurance policy held individually or through superannuation
Purpose	Time away from work for rest, recreation or personal reasons	Income replacement during illness or injury
Accrual Basis	Accrues at a minimum of 4 weeks per year for full-time employees	Does not accrue; payable only during an approved claim period
Payment Rate	Paid at the employee’s ordinary rate of pay	Benefit amount is typically 50-85% of pre-tax income
Payment Timing	Payable when annual leave is taken and approved	Payable after the policy’s waiting period has been served
Conditions for entitlement	Accrues while employed during periods that count as service under the Fair Work Act 2009	Payable only when the policy definition of incapacity is met
Effect of termination	Must be paid out on termination of employment	No payout on termination; cover ends when the policy or employment ends
Tax treatment	Taxed as normal income through PAYG	May be taxed depending on whether premiums were paid with pre- or post-tax dollars

These differences mean that annual leave continues as a statutory entitlement, while income protection benefits are restricted by the policy conditions when employer-paid leave applies to the same period. Given its statutory nature, the operation of annual leave is determined by the Fair Work Act 2009. 

 

 

 

Fair Work Act 2009: Impact on Leave Entitlements and Income Protection

 

The Fair Work Act 2009 sets the minimum requirements for annual leave in Australia. Under the Act, full-time employees accrue 4 weeks of paid annual leave for each year of service, and part-time employees accrue leave on a pro rata basis. These entitlements form a statutory component of the employment relationship.

Uncertainty often arises regarding annual leave accumulation when employees are receiving income protection benefits. This uncertainty reflects the need to distinguish between the statutory rules governing employment entitlements and the contractual rules governing insurance benefits.

Under the Fair Work Act, annual leave accrues only during periods that count as service. Paid leave counts as service, while most unpaid absences do not. Periods during which an employee is receiving income protection benefits are generally treated as unpaid leave, so annual leave does not usually accrue unless an employment contract or industrial instrument states otherwise.

The Act does not prevent an employee from taking annual leave during a period of incapacity, including a period in which income protection benefits are being claimed. However, the Act regulates the employment relationship only and does not determine how income protection benefits are assessed or paid. The insurer’s assessment is governed exclusively by the policy conditions, and many policies contain provisions that reduce or suspend benefits when employer-paid income, including annual leave, applies to the same period.

The statutory framework, therefore, preserves annual leave as an entitlement, while the policy conditions govern the payment of income protection benefits. These frameworks operate independently, and each determines different aspects of an employee’s position during a period of incapacity.

 

When Annual Leave Accumulates Under the Fair Work Act

If annual leave does not accrue during the period of income protection insurance payments, it becomes necessary to identify when it accrues. The Fair Work Act sets the rules that determine annual leave accrual and which periods count as service.

• Employee is working: Annual leave accrues during ordinary working hours for full-time, part-time, and shift workers, including those entitled to five weeks of annual leave.
• Paid leave: Accrual continues during paid absences that count as service, including paid annual leave, paid personal or carer’s leave, paid compassionate leave, paid family and domestic violence leave, paid long service leave where state legislation classifies it as service, and paid leave provided under an award, enterprise agreement or employment contract.
• Public holidays: A public holiday occurring during a period of annual leave does not reduce the annual leave balance and continues to count as service for accrual purposes.
• Paid employer-initiated leave: Annual leave accrues during employer-funded absences, such as paid study leave, paid training leave, and employer-funded parental leave, where it is contractually provided.
• Community service leave that counts as service: Annual leave accrues during paid community service leave, including jury service top-up payments, and during unpaid emergency management leave, as both are recognised as service under the Fair Work Act.
• Workers’ compensation periods (subject to state law): Section 130 of the Fair Work Act restricts accrual during workers’ compensation unless the relevant state or territory legislation permits it. Accruals may continue in jurisdictions where local legislation authorises it.

 

 

Why Annual Leave Cannot Be Paid at the Same Time as Income Protection Benefits

 

The reason annual leave and income protection benefits cannot usually be paid for the same period stems from the purpose of income protection itself. Income protection is designed to replace income lost when a worker cannot perform their duties. 

When annual leave is paid, the worker is receiving income from their employer, and the insurance benefit is provided on the basis that no employer-paid income is being received.

 

Insurers Treat Annual Leave as Income

Income protection policies treat annual leave payments as ordinary earnings because they are taxable amounts paid by the employer for a period in which the employee is not performing work. When annual leave is taken during a claim period, the payment is regarded as income for the same period under the policy’s benefit calculation rules.

Most income protection policies include offset provisions that require the benefit to be reduced or paused when employer-paid income is received. This prevents policyholders from receiving payment twice for the same period; once from their employer through annual leave and once from their insurer through income protection.

This approach reflects the purpose of income protection: to replace lost income rather than supplement earnings.

 

Income Protection Replaces Income Loss Only

Income protection benefits are intended to replace income loss when a worker is unable to perform their duties due to illness or injury. The benefit is calculated on the assumption that the worker has no income from their employer during the claim period. 

When annual leave is taken, the employer pays the employee at their ordinary rate of pay, meaning the worker is receiving income for that period. Most income protection policies contain offset provisions requiring the insurer to reduce or suspend the benefit for any period in which employer-paid income is received, including paid leave, wages, workers’ compensation or other insurance payments.

 

Policy Conditions Operate Independently of Employment Entitlements

The Fair Work Act gives employees the right to access accrued annual leave, but it does not oblige an insurer to continue paying income protection benefits while the employee is receiving paid leave.

The insurer’s assessment is governed solely by the policy conditions. These conditions commonly require the benefit to stop or reduce when employer-paid income applies to the same period, regardless of the employee’s entitlement to take leave under employment law.

 

 

Effect of Taking Annual Leave While Receiving Income Protection Benefits

 

Using annual leave during an income protection claim has clear consequences under most policy conditions. Income protection benefits are calculated on the basis that the employee is not receiving income from their employer, so taking annual leave during a claim affects how the benefit is administered. 

The outcomes are largely determined by two elements common to most income protection policies: the offset provisions that apply when employer-paid income is received, and the requirement to disclose any such income during a claim.

 

Scenario 1: Take Annual Leave and Notify the Insurer

If an employee applies for annual leave and informs the insurer:

• The employer pays the employee at their ordinary rate for the period of annual leave
• The insurer is notified, either directly by the employee or through routine income verification.
• The income protection benefit is reduced to zero for the period of paid leave, as the annual leave payment is treated as income under the policy’s offset provisions.

In this situation, the employee receives only the annual leave payment. While this is compliant with the policy conditions, it may not be financially advantageous. Annual leave is a valuable entitlement, and using it during a claim period may deplete leave that could otherwise assist with a staged return to work or provide flexibility once duties resume.

 

Scenario 2: Take Annual Leave Without Disclosing It to the Insurer

Where annual leave is taken and not reported to the insurer, significant issues can arise. Insurers routinely request updated employer information during a claim to verify income, capacity and ongoing entitlement. Annual leave payments are usually identified during this process.

If paid leave is discovered and was not disclosed:

• The insurer may seek recovery of any overpaid income protection benefits for the relevant period
• Benefit payments may be suspended while the insurer reviews whether policy conditions have been breached.
• In serious cases, the policy may be cancelled for non-disclosure, leaving you without coverage.

Most income protection policies require claimants to declare any income received during the claim period, including paid leave. Failing to report annual leave is treated as a breach of this obligation and can affect both past payments and the continuation of the claim. This requirement forms part of the broader duty to notify the insurer of any change in employment status, duties or income, as outlined in guidance on ongoing disclosure obligations.

 

 

When Employees May Consider Using Annual Leave

 

Given how income protection policies apply offset provisions to employer-paid leave, many employees choose not to use their annual leave during a claim period. Using annual leave while receiving income protection benefits generally results in the insurance payment being reduced or paused, which means the employee receives no additional financial benefit from using their accrued leave.

Employees may prefer to retain their annual leave for use after returning to work, as it can assist with:

• Taking occasional days off to support a gradual return to work
• Attending ongoing medical or rehabilitation appointments
• Taking a period of rest or recovery after returning to duties
• Providing financial support if working reduced hours on return

Annual leave remains an employment entitlement. If it remains unused, it must be paid out on termination in accordance with the Fair Work Act.

There are circumstances where annual leave may still be accessed during or around an income protection claim, depending on policy terms and workplace arrangements. Examples include:

• During the waiting period: When income protection benefits have not yet commenced.
• During partial disability claims: When the employee is working reduced hours and taking annual leave to supplement income, subject to offset provisions.
• At the end of the claim period: When the employee is transitioning back to work and holds a significant annual leave balance.

These situations depend on the employment contract, workplace policies, and the terms of the income protection policy. Employees should confirm the implications with their insurer and employer to understand how annual leave and income protection benefits will be treated.

 

The interaction between annual leave entitlements and income protection benefits is governed by two separate frameworks: the Fair Work Act 2009 and the income protection policy. While the Fair Work Act 2009 entitles you to accrue and take annual leave, income protection insurance doesn’t allow policyholders to receive both benefits simultaneously.

Although you can legally request to take annual leave at any time, doing so while on an income protection claim will almost certainly result in your insurance benefit being reduced to zero for that period due to offset clauses in most policies.

This means that using annual leave during an income protection claim does not provide an additional financial benefit. Thus, preserving annual leave for use after returning to work or for payout on termination of employment often remains the more practical option. However, this depends on the individual’s employment arrangements and the terms of their policy.

Before deciding whether to take paid leave during a claim, employees should:

• Review their policy document, including any offset provisions, definitions of income and conditions relating to paid leave.
• Confirm with their insurer how annual leave would be treated for their specific claim.
• Check with their employer or HR department whether annual leave accrues during unpaid absences.
• Obtain personal financial advice from underwriting agencies such as Aspect Underwriting if they require guidance based on their circumstances.

Understanding how annual leave entitlements and income protection benefits work enables employees to identify how their position may be affected during a period of incapacity. The payment and workplace arrangements determine the payment, so employees must confirm the implications with their insurer and employer to understand their entitlements.

Contact Aspect Underwriting for thorough guidance and to review income protection policies that suit your needs.