Income protection for limited company directors

If you run your own limited company, you will be aware that you alone are responsible for protecting yourself should you be unable to work in the future.

An executive income protection policy can provide peace of mind, as well as tax efficiency, as the premiums can typically be funded by your limited company.

In this article, we explain what income protection is, and how your limited company can fund the costs.

What is income protection?

This type of policy will protect your income should you be unable to carry out your usual work, as a result of an injury or illness.

It is a worthwhile addition to Statutory Sick Pay, which all employees are entitled to. Unfortunately, SSP is a mere £96.35 per week and paid by your employer (your limited company) for up to 28 weeks.

Of course, this level of income replacement is unlikely to be enough for most company directors.

This is where the concept of income protection comes in.

What does this type of policy cover?

Income protection will pay you an income during times when you are unable to work due to sickness or disability.

You will continue to receive payments until you have recovered, retired, or your claim period expires – whichever happens first.

IP cover will typically exclude some pre-existing conditions, self-harm, or illness which results from the misuse of alcohol or other substances.

You will be able to choose the type of cover the policy includes – the most common choices are:

• Level cover – this means that the amount of protection remains the same throughout the term, with no inflationary increases.
• Inflation-linked cover – as the name suggests, the amount of cover will increase annually, according to the inflation times by a multiple.

You can choose how quickly your policy comes into play, as well as the policy term – often until retirement.

Personal vs. Limited Company – how are the premiums taxed?

If you are a traditional employee or a sole trader, all costs for things like life insurance, or income protection, are paid for out of your post-tax personal income.

However, if you run your own limited company, the business is able to access protection products, such as relevant life insurance, as well as income protection cover, which can be funded via the company itself.

As certain products can be offset by your company against Corporation Tax, this tax-efficient from the company’s point of view.

From the director’s point of view, the policies are owned by the company itself, so typically no benefit in kind charge will arise for either Employers’ or Employee’s National Insurance.

How are any payouts taxed?

For executive plans, the limited company is the policyholder, and an employee is the person insured.

When a successful claim is made, the company will receive any income from the policy. Importantly, this income is treated as trading income, and subject to tax when it is distributed.

For personal cover, you have already paid for any premiums out of post-tax income, so any payouts are not taxed further.

Clearly, there is a tax benefit to setting up income protection via your company vs. paying personally, however you should ask your IFA or accountant for a full illustration according to your own personal circumstances.

How much protection can I take out?

Executive protection policies will typically cover you for up to 80% of your income (in a combination of salary and dividends, plus possibly overtime and the value of any P11d benefits).

This compares favourably to personal plans, which may only cover up to 65% of your income, although the proceeds of a successful executive policy claim are taxable, whereas those from a personally funded policy are not.

Some of the leading providers in the market can protect up to £25,000 per month for level cover, and more if the cover is inflation-linked.

It may also be possible to include the value of your spouse’s dividends, although there will be conditions attached to this, such as that the spouse only carries out minimal administrative duties.

You need to choose your deferred period – the amount of time before the policy starts to pay out. This can typically range from 7 days to a year. For obvious reasons, the longer the deferred period, the lower your premiums will be.

Things to consider when taking out cover

• You can only access executive income protection cover if you work via a limited company. If you’re a sole trader, read our guide to IP for the self-employed.
• When working out how much cover you need, it is worth ‘grossing up’ the potential payout received by the company in the event of a successful claim. You can then work out the amount you (the employee) will receive after tax.
• Ensure that your cover is provided on an own occupation basis.
• Consider the deferred period carefully, and how long you would like cover to run for, as these variables can affect the level of premiums considerably.
• In the current climate, it may be sensible to consider inflation-linked cover!
• Make sure you approach an IFA who specialises in the needs of limited company owners. They will understand the intricacies of both how directors operate in practice, and how premiums and payouts are taxed.
• You can get in touch with Broadbench, our recommended IFA via Limited Company Help.