If you take out Executive Income Protection through your limited company, the amount of cover you can get will partly depend on how you pay yourself.
This is important because many company directors take a relatively low salary and the rest of their income as dividends.
If your salary is only a small part of your overall income, will the insurer take your dividends into account as well?
Some Executive Income Protection policies cover both salary and dividends, but the rules vary between insurers.
Here, we look at how salary and dividends are treated when you take out Executive Income Protection through your limited company, and what you should check before choosing a policy.
For a broader introduction to the subject, read our guide to income protection for limited company directors.
Why salary and dividends matter
With Executive Income Protection, your limited company takes out the policy and pays the premiums.
If you’re unable to work because of illness or injury and make a successful claim, the insurer pays the benefit to your company. The company can then use the money to continue paying you while you’re off work.
Before you take out a policy, the insurer needs to work out how much of your income it is prepared to cover.
This can be more complicated for a company director than it is for a conventional employee.
For example, you might receive a salary of £12,570 but take another £40,000 in dividends each year.
If the insurer only took your salary into account, it would base your cover on £12,570 rather than the £52,570 you actually receive from your company.
Fortunately, some Executive Income Protection policies take into account how limited company directors pay themselves.
Can Executive Income Protection cover dividends?
Yes, some Executive Income Protection policies include dividends when working out how much cover you can have.
This is particularly useful if you take a low salary and draw the rest of your income from the company as dividends.
However, don’t assume that every dividend you receive will count.
Your insurer may want to check that the dividends form part of your normal remuneration from the company. It may also look at your shareholding, the company’s profits and your recent dividend history.
The rules vary between insurers, so check how your dividends will be treated before you take out a policy.
What income can be covered?
Some Executive Income Protection policies cover both salary and dividends, but the rules vary between insurers.
| Type of income or cost | Can it be covered? |
|---|---|
| Director’s salary | Yes. Your salary will normally be included when the insurer works out your cover. |
| Director’s dividends | Potentially. Some insurers include qualifying dividends you receive from your company. |
| Bonuses | Some insurers include bonuses when calculating your earnings. |
| Benefits in kind | Some policies may include the value of certain in-kind benefits. |
| Employer pension contributions | Some policies allow you to add cover for employer pension contributions. |
| Employer National Insurance | Some policies also allow the company to cover its employer National Insurance costs. |
Don’t assume that every insurer uses the same definition of earnings. Check what will be included before deciding how much cover to take out.
An example: low salary plus dividends
Suppose you own your limited company and receive:
- £12,570 in salary; and
- £40,000 in dividends.
Your total annual income from the company is £52,570.
If your policy accepts both your salary and qualifying dividends, the insurer may be able to base your cover on a much higher figure than your salary alone.
This doesn’t mean you can necessarily insure the whole £52,570.
Income protection is designed to replace part of your income, not everything you earn, and insurers set their own maximum benefit levels.
But it shows why the treatment of dividends can make such a difference if you’re a limited company director.
Do all dividends count?
Not necessarily. Your insurer will usually want to establish that the dividends form part of the income you receive from working through your company.
There may also be a limit on the amount of dividend income it will take into account.
For example, the insurer may look at your shareholding and the company’s trading profits when deciding how much dividend income to include.
Check the insurer’s definition of earnings rather than assuming all of your dividend income will count.
What evidence of your earnings might you need?
You may need to provide evidence of your earnings when you take out the policy or make a claim.
Exactly what you need depends on the insurer, but you may be asked for:
- payslips or PAYE records;
- dividend vouchers;
- company accounts;
- personal tax returns; or
- other evidence of your company’s profits and the income you receive from it.
This is another good reason to make sure your dividends are properly documented when you pay them.
For more information, read our guide to how limited company dividends are taxed.
What happens if your salary or dividends change?
Your income as a company director may change from one year to the next.
Your company might have a particularly profitable year and pay larger dividends. In another year, you might decide to leave more of the profits in the company.
You might also change the balance between salary and dividends.
If your income changes significantly, check that your income protection still provides the level of cover you expect.
The amount shown on your policy isn’t necessarily the amount you will receive regardless of your circumstances. Your insurer may check your earnings when you make a claim and apply the limits set out in the policy.
If your earnings have fallen significantly, this may affect the amount you receive.
It therefore makes sense to review your cover if there is a major change in the way you pay yourself.
What about profits left in the company?
You don’t have to take all of your company’s profits as salary or dividends.
You may prefer to leave some money in the business, perhaps to build cash reserves or cover future costs.
However, profits left in your company aren’t necessarily treated as your earnings for income protection purposes.
A company can be highly profitable while its director takes a relatively modest income. Your insurer will use its own definition of earnings when working out how much cover you can have.
If you regularly leave significant profits in your company, check how this affects the amount of income you can insure.
For more information on the different ways you can withdraw funds, read our guide to taking money out of a limited company. Also, we recommend you read our guide to the tax treatment of IP policies and claims.
What should you check before taking out cover?
If you receive a mix of salary and dividends, don’t simply compare policies based on the monthly premium.
Check:
- whether your dividends are included;
- which dividends the insurer will recognise;
- what evidence of your earnings you need;
- whether your shareholding affects the calculation;
- what period the insurer uses to work out your earnings;
- what happens if your salary or dividends change; and
- how much you would actually receive if you made a claim.
For a limited company director, how an insurer treats your salary and dividends can significantly affect the amount of income you can protect.
Find out more
If you would like to find out more about Executive Income Protection and how your salary and dividends affect the amount of cover you can get, our trusted partner, Broadbench, will be happy to help.
The Broadbench team has helped hundreds of our visitors over the past ten years.
Simply fill in this form, and the team will get back to you right away.
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