Can salary and dividends both be covered by income protection?
Most limited company directors don’t draw down all of their income as salary. Many pay themselves a modest salary, with the remaining profits distributed to shareholders as dividends.
So what happens when you apply for a new income protection policy? Will insurers cover both the dividend income and your salary?
Why salary and dividends matter for income protection
Salary is relatively easy for an insurer to assess. It goes through PAYE and can usually be confirmed from payslips, a P60 and your tax records.
Dividends are different. They’re paid to shareholders from available company profits and can change considerably from one year to the next.
For many directors, though, dividends make up a large part of their actual income. It would be difficult to achieve the amount of cover you need if they aren’t taken into account.
Take a director receiving a salary of £12,570 and £40,000 a year in dividends. A policy based solely on the PAYE salary wouldn’t come close to replacing the income that person normally lives on.
Can dividends be included in income protection?
Yes, many insurers will consider regular dividends, particularly when they’re paid by the trading company you work for.
The insurer may want to know:
- how much of the company you own;
- whether you work actively in the business;
- how much salary and dividends you’ve received;
- how regularly dividends have been paid;
- whether company profits support those dividends; and
- how long you’ve been receiving them.
Dividends from your own trading company aren’t necessarily treated in the same way as passive investment income from shares you own elsewhere.
There isn’t one calculation used by every insurer. Two providers looking at exactly the same director and company accounts can arrive at different amounts of insurable income.
How does personal income protection treat dividends?
With personal income protection, you own the policy and pay the premiums yourself.
Some insurers will combine your PAYE salary with qualifying dividends when working out how much income they can insure. They’ll usually want evidence that the dividends are regular and supported by the company’s finances.
Others take a different approach, which can make a sizeable difference if most of your income comes from dividends.
For more information on personal cover, read our guide to what income protection is and how it works.
How does executive income protection treat salary and dividends?
Executive income protection is arranged through your limited company rather than personally.
The company owns the policy and pays the premiums. If you’re unable to work and make a successful claim, the insurer pays the benefit to the company.
Depending on the policy, the amount of cover can take account of:
- salary;
- regular dividends;
- employer National Insurance contributions;
- employer pension contributions; and
- certain benefits in kind.
This can make executive cover particularly useful for directors whose PAYE salary represents only a small part of their overall remuneration.
For more information on how company-funded cover works, read our guide to executive income protection for company directors.
How much of your income can you insure?
Income protection isn’t normally designed to replace every pound you earn.
The insurer will usually cover a percentage of the earnings it accepts, subject to its own maximum benefit. Existing sick pay, other continuing income and income protection policies you already have may also be taken into account.
So a director earning £60,000 from salary and dividends shouldn’t assume that £60,000 of annual income can simply be insured.
For more information on choosing a benefit level, read our guide to how much executive income protection you need.
What financial evidence will you need?
If a substantial part of your income comes from dividends, expect the insurer to ask for more than a couple of payslips.
Depending on the application, you could be asked for:
- payslips and P60s;
- SA302 tax calculations;
- tax year overviews;
- company accounts;
- management accounts;
- dividend vouchers;
- business bank statements; and
- details of your shareholding.
If your dividends vary widely from year to year, the insurer may ask to see figures spanning several years.
A new company won’t have the same financial history available. That doesn’t necessarily prevent you getting cover, but the insurer may ask for other evidence of your expected earnings.
For more information on newer businesses, read our guide to executive income protection for new limited companies.
What if your dividends change each year?
It’s perfectly normal for dividends from an owner-managed company to change from year to year.
An insurer may look at several years of figures rather than relying on the most recent dividend payment. The company’s profits and general financial position can also be relevant.
A large one-off dividend immediately before an application isn’t necessarily going to be treated in the same way as a regular pattern of dividends paid over several years.
Do retained profits count as income?
Not necessarily. Profits left in the company aren’t the same as salary or dividends you’ve already taken out.
Some insurers will take retained profits into account, particularly if you own most or all of the company. Others will base the cover more closely on what you’ve actually paid yourself.
If you tend to leave retained profits within the company, check how each insurer handles them.
What about limited company contractors?
This issue comes up frequently for contractors working through their own companies.
You might personally generate virtually all of the company’s turnover while taking only a small PAYE salary. If an insurer doesn’t include your dividends, the amount of cover available could be much lower than your normal income.
Contractors also need to remember that income protection covers an inability to work because of illness or injury. It doesn’t insure you against a contract ending or a period between assignments.
For more information, read our guide to income protection for limited company contractors.
Check how your income will be treated
If dividends make up a large part of your income, don’t compare policies on premium alone.
Find out how much of your salary and dividends each insurer will actually recognise. A cheaper policy isn’t much use if its calculation leaves you with substantially less cover.
A specialist IFA can check which insurers will include your salary and dividends when working out how much cover you can get.