Executive Income Protection for Directors

If you run your own limited company, you have an option that an employee or a sole trader does not: you can have your company buy your income protection for you, rather than paying for it out of money you have already been taxed on. That arrangement is called executive income protection, and for a lot of owner-directors it is the more sensible way to hold the cover.

It is also widely misunderstood. The tax relief going in is real, but it comes with a trade-off on the way out that is often glossed over, and the structure has one significant weakness that only shows up when your relationship with the company changes. This guide covers how it actually works, what it can insure that a personal policy cannot, and where it falls down.

What executive income protection is

Executive income protection is a standard income protection policy held in a different place. The mechanics of the cover itself are the same as any other plan: it pays a monthly income if illness or injury stops you working, typically replacing 50 to 70 percent of earnings, after a chosen waiting period, until you recover, return to work, or reach the end of the policy term.

What differs is the ownership:

• The company is the policyholder and pays the premiums.
• You are the person insured — the life whose health the policy responds to.
• If you claim, the insurer pays the benefit to the company.
• The company then passes that money to you through payroll, in the same way it pays your salary.

That last step is the part people miss, and it drives most of what follows. The money reaches you as employment income, not as an insurance payout.

If you want the underlying mechanics — deferred periods, claims definitions, how benefit levels are set — the complete guide to income protection covers them in depth. This guide assumes those and focuses on what the company-paid structure changes.

Why the company pays: the tax position going in

The appeal of an executive plan is straightforward. The premium is met by the company, and it is generally treated as an allowable business expense — a cost incurred wholly and exclusively for the purposes of the trade. Where that applies, it can attract corporation tax relief, which means the real cost to the business is lower than the headline premium.

Just as importantly, an executive plan is usually not treated as a benefit in kind for the person insured. Because the company owns the policy and any benefit is paid to the company rather than to you personally, there is normally no additional personal tax charge on the premium. Contrast that with a company simply paying for a policy you own personally, which would ordinarily be treated as a benefit in kind and taxed accordingly — a common and expensive mistake.

Two caveats, both of which matter:

• HMRC looks at the substance of the arrangement, not the label on it. The treatment above is the normal outcome for a genuine commercial arrangement, but it is not automatic, and an arrangement that exists mainly to extract value tax-efficiently can be looked at differently.
• Tax treatment depends on your individual circumstances and may change in the future.

Confirm the treatment with your accountant before you set the policy up, not afterwards. Getting the ownership right at outset is far easier than unpicking it later.

The catch: how the benefit is taxed on the way out

Here is the part that is often left out of the sales pitch. Relief on the way in is matched by tax on the way out.

When you claim, the insurer pays the benefit to your company. Your company then pays it to you through PAYE, where it is taxed as employment income — income tax and National Insurance, exactly as your salary would be. The company will also usually have employer National Insurance to account for on that payment.

So the two routes are mirror images:

• A personal policy gives you no relief on the premium, but the benefit arrives tax-free.
• An executive plan can give the company relief on the premium, but the benefit arrives taxed.

This has a practical consequence when you decide how much cover to buy. Because an executive benefit is taxable, a given level of cover produces less money in your hand than the same figure would under a personal policy. Cover set purely on a headline percentage can therefore leave a bigger hole than expected at exactly the wrong moment. The level of cover needs to be set with the tax treatment in mind — which is a conversation to have with an adviser and your accountant together, before the policy is written.

Personal vs executive: a side-by-side

The two structures pull in opposite directions on almost every point.

Under a personal policy

• You own it, and it moves with you between jobs, companies and contracts.
• Premiums come from already-taxed income — your salary and dividends.
• There is no corporation tax relief on the premium.
• There is no benefit-in-kind question, because the company is not involved.
• Any benefit is paid directly to you, tax-free.
• It is unaffected by what happens to the company.

Under an executive plan

• The company owns it and pays the premiums.
• Premiums are usually an allowable business expense and can attract corporation tax relief.
• It is generally not a benefit in kind for you personally.
• Any benefit is paid to the company, then to you through PAYE, taxed as income.
• It can often insure dividends, employer National Insurance and pension contributions as well as salary.
• It does not travel with you if you leave or close the company.

For a higher-rate owner-director running a profitable company, meeting the premium with pre-tax company money is frequently the more efficient structure. But it is not automatically the right answer, and the deciding factors are your remuneration mix, your company's profitability, your marginal rate, and how long you realistically expect to keep trading through that company. Tax treatment depends on your individual circumstances and may change in the future.

Who can have it — and who cannot

Executive income protection is an employment benefit, so it requires an employer to take it out and pay for it. That draws a hard line:

• Directors of their own limited company — available. Your company employs you, so it can put the arrangement in place for you. This is the typical case.
• Employees of a company — available, where the employer is willing to arrange it. It is often used for a small number of senior people rather than the whole workforce.
• Sole traders — not available. There is no employer, so there is no one to own and pay for the policy. A personal plan is the route, paid from taxed income with the benefit arriving tax-free.
• Equity partners in a partnership or LLP — generally not available for the same reason. Partners are not employees of the partnership.

This is the same distinction that governs relevant life cover, the company-paid life insurance equivalent. If you can use one, you can usually use the other, and directors often arrange both — relevant life to provide death-in-service style cover for the family, executive income protection to keep the income running if you are too ill to work. They cover different risks and neither substitutes for the other.

Contractors have an extra layer to think about here, because IR35 determines whether you are trading through your own company at all. The guide to income protection for IT contractors covers how inside and outside IR35 engagements change what is open to you.

Covering more than just salary

This is where executive plans do something a personal policy genuinely cannot, and it is the reason many owner-directors end up preferring them regardless of the tax arithmetic.

Most owner-directors pay themselves a small salary and take the rest as dividends. Under a personal policy, evidencing that income can be awkward. Under an executive plan, insurers will usually take the whole remuneration package into account — salary and dividends drawn from the company — which tends to produce a more realistic level of cover for how directors actually pay themselves.

Executive plans can also typically insure costs that sit with the company rather than with you:

• Employer National Insurance on the benefit being paid out, so the payment is not eroded by the cost of making it.
• Employer pension contributions, so your retirement saving does not quietly stop for the duration of a long claim — which, over a multi-year absence, can matter more than people expect.

Covering these adds to the premium, so they are a judgement call rather than an automatic inclusion. But the option exists, and a plan arranged without considering them can leave the company absorbing costs at a point when it is already carrying a director who cannot work.

If you leave or close the company

The weakness of the structure is ownership. The policy belongs to the company, not to you. While that relationship holds, the arrangement works well. When it changes, the cover is exposed.

If you take a permanent role, wind the company up, sell your shareholding or otherwise stop being employed by it, the cover would ordinarily come to an end. That would leave you needing new cover — at whatever age you have then reached, and with whatever health conditions you have developed in the meantime. For anyone who has had so much as a back problem or a period of poor mental health since the original policy started, replacing cover can mean exclusions, higher premiums, or difficulty getting cover at all.

Some insurers offer routes around this — transferring the policy to a new employer, or converting it to a personal plan, in some cases without fresh medical underwriting. The availability and terms vary considerably between providers, and it is not something you can assume is there.

Ask about the position at the outset, while you still have a choice of insurer, rather than at the point you need it. For a director who expects to trade through the company for the long term, this is a manageable risk. For someone who might well go permanent in a few years, it is a real argument for holding cover personally instead — or for splitting cover across both structures, which is a legitimate approach and one worth raising with an adviser.

What it costs

Premiums depend on your age, the level of cover, the deferred period, whether you insure dividends and company costs as well as salary, the claims definition you choose, your health and smoker status, and your occupation. Desk-based professional roles sit in the most favourable pricing bands; manual occupations cost more for the same cover.

Any figures you see quoted are illustrative ranges, not quotes — the only way to know your premium is to have your circumstances assessed. You can usually bring the cost down with a longer deferred period, a slightly lower benefit, or by comparing guaranteed against reviewable premiums.

The comparison that matters for an executive plan is not premium against premium, but the net cost to the company after any corporation tax relief, against the net benefit you would actually receive after PAYE. Comparing the headline premiums of a personal and an executive plan side by side tells you very little.

How to arrange it

For an executive plan, the things to get right are the ownership and tax treatment (settled with your accountant before the policy is written), the claims definition — insist on own occupation, which pays if you cannot do your own job rather than any job at all — the benefit level set with the PAYE treatment in mind, what the plan covers beyond salary, and what happens to the policy if you stop being employed by the company. Off-the-shelf cover routinely cuts corners on exactly these points.

It is also worth looking at the wider picture while you are at it. The business protection guide for directors covers key person, shareholder and loan protection, and relevant life cover is the company-paid life insurance counterpart to this. Tax treatment depends on your individual circumstances and may change in the future.

Get advice from a regulated adviser who can search the whole market and structure the policy correctly for a limited company, and confirm the tax treatment with your accountant. Cover Your Family is not FCA regulated and does not give advice — we connect you, free of charge, with a separate, FCA-regulated adviser who provides whole-of-market income protection and business protection advice with no obligation. Enquire today to find out what cover is available for you and your company.