Complete Guide to Executive Income Protection Insurance
Over the years I have helped hundreds of clients take advantage of tax efficient life insurance also known as relevant life policies. Many of these clients asked me whether there were ways in which they could get their businesses pay for a policy that would cover illness or sickness such as a critical illness policy. Unfortunately there was no tax efficient to offer this type of policy. However the Executive Income Protection solution plugs that gap nicely. This short post will look at this tax efficient way for company directors to provide cover to protect their incomes against illness or sickness. It is also often used to give employees an employee benefit package superior to other employers and can aid employee retention and attraction.
The need for sickness or long term illness cover.
Typically executive income protection policies are taken out by company directors of small limited companies. In effect these clients are self-employed should they suffer from a long term illness or sickness they would not receive sick pay from their employers. They may have some reserves in the limited company but these would soon run out.
Many clients try protecting their families from the effects of death by taking a tax efficient relevant life policy. However although that offers a good start the more likely risk as that of a critical illness or long term illness.
The chart below compares the risk of dying with the risk of being diagnosed with a critical illness for a non-smoking man aged 40. It also shows how the risk of critical illness increases drastically with age.
The chance of claiming for an income protection policy are even more likely than claiming under a critical illness policy. The majority of claims for income protection are for mental illnesses and muscular skeletal illnesses. The majority of critical illness policies would not cover such illness so the income protection is more comprehensive.
Executive Income Protection – how it works.
The limited company takes out an income protection policy on the employee or director. The company uses the premium as a business expense. Thus saving the director the tax and national insurance that they would have paid if they paid for the policy personally. In the event of a claim the monthly sum assured is paid to the limited company. This is classed as income into the business just like a trading receipts.
It is a condition of the policy that the employer must pay the employee through the pay as you earn scheme, while they are unable to work.
Options Available with Executive Income Protection.
Typical maximum sum assured will be 75% of an employee’s pre-incapacity earnings less the state long term incapacity benefit for a single person.
Cover can include:
– Employee pension contributions.
– Employer pension contributions.
– Employers National Insurance.
– There is a range of deferred periods although typically most directors opt for a 12 week or 3 months deferred period.
Faqs on Executive Income Protection
[iconbox layout=”icon-title” title=”What happens if the company is sold, taken over or goes bust?” icon=”fa-shopping-cart”]If the company is sold or taken over the policy can be transferred from one company to another company by assignment. If the company goes bust and the income protection is already being paid the provider will continue to pay the benefit but on a personal basis directly to the employee.
Also if there is a claim being paid and you decide to sell the company the same situation would occur as if the company had gone bust. The sum assured would be paid directly to the employee
[iconbox layout=”icon-title” title=”How much cover should you have?” icon=”fa-money”]For many directors the sum assured taken is the maximum allowed by the policy. However others do not have the budget to pay for a potentially high monthly premium. For clients that want a lower sum assured they need to ascertain how much they could live off each month. Many clients take £3000 or £2000 per month as the sum assured to keep the costs down. However in the event of a claim they know that they could still live on this amount so are OK with the lower sum assured.
[iconbox layout=”icon-title” title=”What deferred period should you have?” icon=”fa-clock-o”]Tax efficient income protection for company directors known as Executive Income Protection should have a deferred period to match the director’s savings or priorities. If the director has savings and can easily pay for 6 months living costs without effecting his savings dramatically then they may opt for a longer term deferred period. On the other hand if the director has no savings then a shorter perhaps 1 month or 3 month deferred period should be selected. The shorter the deferred period the higher the premium..
Example 1 – IT Contractor
Many IT contractors work through their own limited company. Many of these previously have worked for banks and other big financial institutions. When they became contractors they lost the sick pay that was provided from the employer. Many want to put something in place to ensure their income is protected in the event of long term sickness. The executive income protection provides a tax efficient way to pay for this.
Example 2 – Company Director
For many company directors even those that have larger businesses with many employees and even for those where 3 or 4 shareholders own the business an executive income protection can be very useful. If one shareholder becomes ill and cannot work continuing to pay that shareholder their wage can put financial strain on the business. In this instance the company director can take an executive income protection policy to ensure that the wage they get can be paid for from the proceeds of the policy upon a claim.
Example 3 – Employee
Attracting high calibre talented employees is important for both small and big businesses. Many would want a sick pay package, typical sick pay packages would consist of 6 or 12 months full pay etc. By taking an executive income protection policy with a pay out period of up to age 65 the employer can offer the employee a sick pay package of many years not just 6 or 12 months. This can help attract and retain employees, plus the cost of the policy is a business expense.