Executives can make the most of income protection – Birmingham Post article 31.12.2020

Last week I talked about how coronavirus had highlighted the importance of income protection.

Well, there is also a ‘version’ for owners and directors of businesses.

Executive income protection is similar but distinct.

Both kick-start a regular monthly sum if you can’t work for any medical reason, for example you are signed off long term sick. However, they are treated differently for tax purposes because who pays for the policy is different.

With a personal policy, it is down to you yourself. A claim is tax-free because you’ve already been hit for tax on the premiums.

Executive income protection is owned and met by the business. Hence, a claim is typically taxable because you paid no tax along the way.

The appeal is to small firms in particular, those that do not have a sufficient number of employees to offer a group income protection scheme, and where key individuals stand out.

Maximum benefits vary according to the provider – 80 per cent of the employee’s annual earnings up to £300,000 is typical, employer pension contributions can be of the order of £40,000 to £50,000, with employer National Insurance around the £40,000-plus mark.

For employers, corporation tax comes out tax neutral (as long as the arrangement is wholly and exclusively for the purposes of the business) plus there is no National Insurance on the policy payments. For an employee, the policy payments are exempt from benefit in kind taxation.

Aegon provides the following illustration:

Dan is a company director aged 40. He is part of a workplace pension scheme with contributions by both him and the company, with the intention he retires at 65 with an income of £30,000 a year.

Nevertheless, Dan also knows that should anything happen to him (accident or illness), and he is unable to work, he has no other income. Therefore, he decides to take out income protection.

He could opt for personal income protection in which case his circumstances might unwind thus…

Dan, now aged 50, becomes unwell and has to make a claim on his personal IP policy. With personal IP, your pension contributions are restricted to a maximum of £2,880 a year (£3,600 after tax relief). However, as Dan could only insure a maximum of 62 per cent of his income, he can’t even afford this, so stops them altogether. And as the policy doesn’t provide cover for the company to continue making employer contributions, those stop too.

The outcome is that Dan has protected his income until his retirement age when his personal IP policy ends. However, instead of potentially enjoying a generous pension, it could be worth much less as he’s been unable to contribute to it for the last 15 years.

What if Dan had opted for executive income protection?

Same scenario – Dan reaches 50 and becomes unwell.

As the executive IP claim payments go to the company, it can use this to continue paying Dan 80 per cent of his monthly salary. Dan can therefore afford to keep his pension payments ticking over. The executive IP policy covers the company’s employer pension commitments, so it can continue putting into Dan’s pot.

So, when Dan reaches age 65 and his claim payments stop, his pension could potentially be the £30,000 a year he envisaged.

His ill-health is still a concern but in other respects he is a happy man.

Again, maximum age limits vary between providers and can be significantly reduced for driving-based occupations, fitness instructors and the like. If the employee leaves the business, a new employer can continue the policy.

So, overall, executive income protection is well worth considering.