This article provides an overview of income protection cover for professional contractors and other small company owners.
Overview of Income Protection
Unlike permanent employees, who are usually provided with several months’ salary if they become ill, or have an accident, contractors are completely responsible for their own financial well-being any time they are forced to have off from work due to illness.
Income Protection (IP) policies redress the balance. Once you set up and make payments towards an IP policy, you will be supported financially if you are unable to work. Contractors can choose to pay for income protection policies themselves, or via their limited companies
Personally funded plans pay benefits tax-free whereas premiums paid by the company are taxable as a benefit in kind but the monthly premiums you pay are viewed as ‘legitimate business expenses’ and so can be offset against corporation tax (see below for further details).
How Income Protection Works
Depending on the policy taken out (and the monthly premium), an income protection company will pay out a proportion of your income after a ‘deferred’ period has expired.
This deferred period is simply a pre-agreed waiting period (typically between four weeks and a year). As you would expect, the longer the waiting period, the lower the premiums for cover.
Clearly, if you have savings and would be able to cover your expenses for several months in the event of illness or an accident, you may be better off electing to have a longer waiting period, as your monthly premiums would be lower.
You may wish to cover up to 70% of your income. Naturally, the higher the level of cover you take out, the higher the monthly premiums with be. It is essential that you calculate a realistic level of cover to protect you and any dependants if you can’t work.
Make sure that your financial advisor is a contractor specialist, as the nature of the industry we are in has its own characteristics and uncertainties. They will be able to tailor a policy to your exact requirements, knowing fully how contracting works.
Income Protection Tips
- Make sure the IP company has a good record of meeting past claims, as payment delays can be very stressful. An experienced contractor financial advisor will have personal experience of a number of companies and will be able to recommend a good selection.
- Ensure that the policy will pay out if you cannot carry out your stated occupation (e.g. as a programmer), as less contractor-friendly cover may insist that you can carry out a menial job despite being ill… even if you’re unable to work as a programmer. The cover should reflect the fact that you need cover as a skilled professional person.
- Make sure your IP policy covers you until your chosen retirement date (60 or 65 usually). You would expect a policy to cover you up to the date your pension starts to pay out.
- Make sure you inflation proof your benefit level. £3000 per month in 20 years’ time will be worth far less! You can ensure the insured levels increase by an agreed amount each year – either a fixed percentage or in relation to the Retail Price Index.
Company or individual policy?
If you take out an insurance policy via your own limited company, any premiums paid are likely to be treated as a legitimate business expense by your accountant, but there may be personal tax implications if these premiums are seen as a ‘benefit in kind’.
If you take out an individual policy, you need to fund any premiums out of your post-tax income. However, any claim-related funds you acquire if you are unable to perform your contract duties would be tax-free.
If you make a claim on your limited company policy, any incoming funds would be subject to corporation tax, and you (as an individual) would also be subject to tax and NICs when the funds are paid to you from the company.
We recommend you speak to a specialist financial advisor to work out which is the best route for you to take.