Executive income protection tax for company directors
One of the main attractions of executive income protection is that a limited company can pay for the policy on behalf of a director or employee.
Where the policy is arranged correctly, the premiums may qualify as an allowable business expense and are not normally treated as a benefit-in-kind. Any successful claim is paid to the company and will generally be taxable as business income.
Directors can also arrange personal income protection and pay the premiums from their own taxed income. There is no tax relief on a personal policy, but claim payments are normally received tax-free.
The broad distinction is that company-paid policies may provide tax relief on the premiums, while personal policies normally provide tax-free claim payments.
Company-paid vs personal income protection
| Company-paid executive policy | Personal policy | |
|---|---|---|
| Policy owner | Limited company | Individual |
| Premiums paid by | Limited company | Individual from post-tax income |
| Corporation Tax relief | May be available | Not available |
| Benefit-in-kind | Not normally applicable | Not applicable |
| Claim paid to | Limited company | Individual |
| Tax on claim | Generally taxable within the company | Normally tax-free |
| Typical cover | May include salary, dividends and certain employer costs | Based on a proportion of personal income |
How are company-paid premiums taxed?
With executive income protection, the limited company owns the policy and pays the premiums directly to the insurer.
HMRC may allow the company to deduct the cost when calculating its taxable profits, provided the policy has been arranged for a genuine business purpose and satisfies the relevant tax rules.
The principle is that the policy protects the employer against the financial consequences of a director or employee becoming unable to work. It should not primarily provide the insured person with a personal investment or capital benefit.
HMRC discusses the tax treatment of insurance covering employees, directors and other key persons in its Business Income Manual at BIM45525. Broadly, premiums may be deductible where the policy is taken out solely to protect the trade against the financial consequences of a director or employee being unable to work, rather than to provide a capital or personal benefit.
Where a deduction is allowed, the premiums reduce the profits on which the company pays Corporation Tax.
Tax relief is not automatic. The policy should be arranged wholly and exclusively for the purposes of the trade, and the ownership and structure of the policy should reflect its business purpose.
Is executive income protection a benefit-in-kind?
Executive income protection premiums are not normally treated as a benefit-in-kind where the company owns the policy and receives any claim proceeds.
This means the director or employee will not usually pay Income Tax or employee National Insurance on the premiums. The company will not normally need to include the cost on a P11D.
The position differs from an arrangement under which the company pays the premiums for a personal policy owned by the director. In that situation, the premium could be treated as a taxable benefit because the company is meeting a personal expense.
The ownership of the policy is therefore important. An executive policy should be established in the company’s name, with the company paying the premiums and receiving any benefit.
Further information about taxable employee benefits is available through the GOV.UK expenses and benefits guidance.
How are executive income protection claims taxed?
If a valid claim is made, the monthly benefit is normally paid to the limited company rather than directly to the insured director.
The claim payments are generally recorded as income in the company accounts and may be subject to Corporation Tax.
The company can then use the money to continue remunerating the director or employee. The tax treatment will depend on how the money is paid:
- Salary or bonus: Payments are subject to PAYE and National Insurance in the normal way.
- Dividends: Any distribution must comply with the usual company law requirements and will be subject to the normal dividend tax rules.
- Employer pension contributions: These may be possible where the policy and insurer allow relevant employer costs to be included.
A claim payment does not become tax-free merely because it arose from an insurance policy. The company receives the benefit as part of the arrangement under which it claimed tax relief on the premiums.
Can the policy cover salary and dividends?
Many limited company directors take a relatively small PAYE salary and receive the remainder of their income as dividends.
Executive income protection policies often take both elements into account when calculating the available benefit. This can allow a director to insure more of their normal remuneration than they could under a policy based only on salary.
Insurers do not all treat dividends in the same way. They may consider:
- The director’s shareholding in the company.
- Whether the dividends arise from the director’s work.
- The company’s recent accounts and trading profits.
- Whether dividends are shared with another shareholder.
- How consistently dividends have been paid.
Some executive policies can also include employer National Insurance contributions, pension contributions and certain company-funded benefits, subject to the insurer’s limits.
Our guide to how much income protection a director may need looks at benefit levels in more detail.
How are personally paid premiums taxed?
A director can instead take out a personal income protection policy and pay the premiums from their own bank account.
There is no Income Tax or Corporation Tax relief on the premiums because they are paid from income that has already been taxed.
The advantage is that a successful claim is normally paid directly to the policyholder and is usually tax-free.
Personal cover may be appropriate where:
- The individual does not operate through a limited company.
- The director wants claim payments made directly to them.
- The policyholder prefers a personal arrangement that is independent of the company.
- The available executive policies do not suit the director’s circumstances.
However, personal policies may insure a lower proportion of income and may not account for company-funded pension contributions or employer costs in the same way as executive cover.
Which structure is more tax-efficient?
For many limited company directors, executive income protection provides an efficient way to fund cover because premiums are paid by the business rather than from personal post-tax income.
That does not mean the company-paid route is always cheaper overall. Claim payments received by the company are generally taxable, and any remuneration subsequently paid to the director is taxed under the normal rules.
A personal policy works the opposite way: there is no relief when the premiums are paid, but claim payments are normally received without an additional tax charge.
The appropriate structure will depend on:
- How you take income from your company.
- The amount of salary and dividends you want to protect.
- Whether you want the company or the individual to receive a claim.
- The level of cover available under each type of policy.
- Your company’s financial position.
Common director questions
Can a one-person limited company claim tax relief?
Potentially, yes. A company does not need to employ a large workforce to arrange executive income protection.
A one-person company can insure its director, provided that the director is an employee, the company owns the policy and the arrangement has a genuine business purpose.
Whether the premiums are deductible depends on the terms and circumstances, not on the number of people employed.
Does the policy need to be reported on a P11D?
Not normally, where the company owns the executive policy and receives any claim proceeds.
A P11D issue may arise if the company pays for a policy that is personally owned by the director or provides a benefit that falls outside the normal executive income protection structure.
Does Corporation Tax relief apply automatically?
No. The fact that a premium has been paid from a business bank account does not automatically make it deductible.
The policy must be arranged for the purposes of the business and satisfy the normal rules for allowable expenditure. Your accountant should confirm the treatment based on the actual policy structure.
Are claim payments always subject to Corporation Tax?
Claim proceeds paid to the company are generally treated as taxable income. The company’s associated payments, such as salaries and employer National Insurance, may also be deductible expenses when calculating taxable profits.
The final company tax position therefore depends on both the income received and the costs paid out.
Can executive income protection cover dividends?
It often can, although the insurer will usually require evidence that the dividends are linked to the director’s work and supported by the company’s profits.
The maximum level of dividend cover and the evidence required vary between insurers.
Common mistakes to avoid
- Assuming every company-paid premium is deductible: The ownership, purpose and terms of the policy must support the tax treatment.
- Using the company to pay for a personal policy: This may create a benefit-in-kind rather than the intended executive arrangement.
- Ignoring the tax treatment of claims: Executive policy benefits are paid to the company and are not normally tax-free.
- Assuming all dividends can be covered: Insurers use different calculations and may exclude dividends that are not linked to the insured person’s work.
- Looking only at the premium: The deferred period, incapacity definition, benefit term and cover calculation can be more important than a small difference in cost.
Choosing the right arrangement
Company-paid executive income protection is often well suited to directors who want their limited company to fund the premiums and protect a combination of salary and dividends.
Personal cover may be more suitable where the individual wants to own the policy, receive claim payments directly or does not operate through a limited company.
Before applying, it is worth checking the proposed structure with both a regulated adviser and your accountant. The adviser can compare policy terms and benefit calculations, while your accountant can confirm the likely tax treatment for your company.