As a limited company director, you typically only get paid when you work, particularly if you provide professional services to clients.
If you’re unable to work because of illness, it can strain your finances. While you may be able to bridge the gap with savings, this isn’t a long-term solution.
This is where an income protection policy can give you the support and security you need when you need it most.
This type of policy will provide you with a pre-agreed monthly income to help cover expenses until you are well enough to return to work and start earning again, subject to the terms of the policy.
When it comes to insurance, there are always clauses and caveats to what is and isn’t covered, and the old adage of shopping around for the best deal certainly applies.
Here, we examine how income protection (IP) works in practice and what to consider when choosing an insurer.
Income protection in a nutshell
IP cover can be arranged to pay you a fixed monthly sum if you’re off sick or suffer a long-term illness or injury which prevents you from working.
The policy can be put in place to cover you up to the point you retire, although you may decide you only need cover until you have paid off a mortgage, for example, or until your children are no longer dependent on you.
The amount of benefit you can insure is usually based on a percentage of your earnings, while the ‘deferred period’ determines how long you have to be unable to work before payments start.
Deferred periods vary between policies. Common options include 4, 8, 13, 26 or 52 weeks, although other periods may be available.
Generally, the longer the deferred period you select, the lower your premium will be. However, you need to be sure you have the funds to cover you for the intervening weeks or months.
If you lack funds, a shorter deferred period is likely to be your best option.
Some policies have “stepped” deferred periods. This means you receive part of the benefit at first, followed by the full amount after a set period.
How long will income protection pay out?
Another important distinction is the maximum benefit period.
Some policies are designed to pay for a limited period for each claim, such as one or two years. Other policies can continue paying while you remain unable to work, potentially until the policy’s chosen end age.
Long-term cover will usually cost more, but it can provide considerably greater protection if you develop an illness or injury that prevents you from returning to work for many years.
What income protection does not cover
Income protection insurance covers many illnesses and injuries that prevent you from working, either in the short or long term, subject to the policy’s definitions and exclusions.
Importantly, it is not a ‘loss of contract’ type of business insurance, where you have lost your job or had your contract terminated.
IP insurance covers loss of income due to illness or injury.
It typically does not cover pre-existing conditions unless they are specifically disclosed and accepted by the insurer during underwriting.
How to pay for income protection
As a limited company director, you can pay for income protection personally or arrange executive income protection through your company.
With executive income protection, your company owns the policy and pays the premiums. If you make a successful claim, the benefit is paid to the company, which can use the funds to continue paying you.
The amount of your earnings that can be covered varies by insurer and policy. This is particularly important for directors who take a low salary and the rest of their income as dividends.
Paying for IP via your limited company may also mean the premiums qualify as a deductible business expense for Corporation Tax purposes, depending on the circumstances.
Company-paid vs personal income protection
| Executive income protection | Personal income protection | |
|---|---|---|
| Who owns the policy? | Your limited company | You personally |
| Who pays the premiums? | Your company | You, from your personal income |
| Who receives the benefit? | Your company | You personally |
| Tax relief on premiums | Premiums may qualify as a deductible business expense, subject to the usual tax rules | No tax relief is normally available |
| Tax on the benefit | The company receives the benefit and uses it to fund your remuneration, which is taxed in the usual way | Benefits are normally paid tax-free |
| Salary and dividends | Some policies can take both salary and dividends into account | Treatment varies between insurers and policies |
Will I pay any tax if the policy pays out?
If you pay for a policy personally from your own taxed income, any benefits you receive in the future are typically tax-free.
However, if your company owns the policy and pays the premiums under an executive income protection arrangement, the benefit is paid to the company upon a successful claim.
The company can then use the money to continue paying your remuneration, which is taxed in the usual way.
This is another consideration to take into account when deciding which type of policy is appropriate for you.
Read more in our guide to the tax treatment of income protection policies.
What to look for in an IP provider
- You should always look for a reputable provider who is experienced in dealing with small business owners and understands how professional contractors operate. Ask your accountant or financial adviser for help, especially with the kinds of exclusions to look out for.
- Make sure you understand the policy’s definition of incapacity. An ‘own occupation’ policy generally provides the strongest definition, because it assesses whether you’re able to perform your own occupation rather than whether you could perform some other type of work.
- Check the policy covers you for the period you want, for example, until you retire. Also check whether each claim can be paid for only a limited period or potentially for the full term of the policy.
- Look for a provider who understands how professional contractors / small company directors operate and is prepared to be more flexible, making changes to your policy as your circumstances change.
- Consider whether you want your IP policy to be index-linked so that the level of cover can rise with inflation. Bear in mind that premiums will normally increase as the benefit increases.
- If you pay yourself a modest to low salary and take the balance as dividends, as many company owners do, check that your policy accounts for this. Some providers may not treat dividends in the same way as salary when calculating the income they are prepared to insure.
- Find out whether the insurer offers “guaranteed insurability options” allowing you to increase cover without new medical underwriting if your financial situation changes, such as getting a larger mortgage or having children.
- Some policies come with value-added services, such as rehabilitation support, mental health services, or access to virtual GPs – features that can aid recovery and facilitate an early return to work.
Are there any drawbacks to income protection?
As with any form of insurance, you should expect to answer a series of eligibility questions and may be required to undergo medical checks before a plan is issued.
You may be asked about any previous illnesses or inability to work caused by a medical condition.
If you’ve had time off due to stress or suffer from a bad back, for instance, this could impact the level of cover you are offered, the premium you pay or the exclusions applied to the policy.
IP is designed to cover loss of income due to illness or injury and will not pay out simply because a contract is cancelled or you stop earning for another commercial reason.
Cover for unemployment, redundancy or loss of contracts is a different type of insurance and should not be confused with income protection.
Find out more
If you would like to learn more about how income protection works in practice and the potential tax benefits of paying premiums through your own limited company, our trusted partner, Broadbench, will be happy to help.
The Broadbench team have helped hundreds of our visitors over the past ten years.
Simply fill in this form, and the team will get right back to you.
Get an Income Protection quote
Fill in your details below and an adviser from Broadbench will get in touch to discuss your income protection options and provide a quote.
