Protecting your income with insurance can be expensive. You could get your company to pay, but this triggers a tax bill either on the cost of the premium or instead when the policy pays out. Can you legitimately avoid both these situations?
Directors and employees
Once upon a time income insurance was most popular with self-employed individuals and business partners, but these days it’s not uncommon for directors and senior employees to be covered under a firm’s group policy. These will pay out if you’re unable to work as a result of ill health, disability or even redundancy. But the premiums don’t come cheap and neither does the tax bill that goes with them.
The unusual thing about income protection insurance (IPI) is that there are two ways in which it can be taxed and HMRC allows you to choose between them.
Option 1 – tax-exempt premiums
Where your company pays the IPI premium on a policy from which you will benefit you might expect that this would count as a benefit in kind (BiK). But actually your company can choose not to declare it as one.
Trap. Where you’re not taxed on the premium as a BiK and you make a claim on the policy, anything paid to you by the insurance company will count as taxable income. A large payout will therefore result in a correspondingly large tax bill.
Option 2 – tax-exempt payouts
Your company can instead choose to report the premiums on the annual benefits and expenses return Form P11D. In this case you’ll be taxed on a BiK. Premiums vary widely depending on the terms of cover, your age and health. But even at the bottom end these can approach £1,000 and could easily be double this. So if your company is paying £2,000 per year in premiums, as a 40% taxpayer you’ll have an annual tax bill of £800 and your company will have to pay Class 1A NI at 13.8% of the premium, i.e. £276.
Which option is most tax efficient?
Working on the principle that a bird in the hand is worth two in the bush it might seem sensible to opt not to be taxed on the premium as a BiK. That way if you don’t claim on the policy there will never be a tax bill. But, of course, you can’t be sure you won’t claim. If you did and the policy paid out, say, £30,000, the tax on this could be £12,000 if you’re a 40% taxpayer.
Here are some specialist business tips to protect your income:
Tip. Your company should opt not to declare premiums as BiKs; this means there will be no tax on these. But in a year when you make a claim it should report the IPI as a BiK on Form P11D. This will mean the policy payout is tax exempt. The maximum tax you’ll pay is therefore on the value of one premium for a single year.
Example. In April 2012 your company pays a premium on an IPI group policy of which £2,000 relates to you. It didn’t intend to declare this as a BiK, but in September 2012 you fell seriously ill and couldn’t work for several months. The insurance company pays out £15,000 which would normally be taxable (£6,000 at 40%). To avoid this your company reports the £2,000 premium on your Form P11D for 2012/13. You’ll pay tax on the £2,000 premium (£800), but save the £6,000 tax on the policy payout.