Income protection for contractors: how it works and what it covers

Permanent employees receive a wide range of employment benefits, including protection if they are unable to work due to illness or injury.

If you work for yourself, on the other hand, you are responsible for protecting your income and dependants if you can’t carry out your contracting duties.

Fortunately, one type of insurance, income protection, can help to redress the balance.

Once you set up a policy, you will receive financial support if you’re forced away from work due to sickness or injury.

Income protection in a nutshell

• Provides a regular monthly income if you’re unable to work due to illness.
• Policies pay out after a pre-agreed deferred period, usually between four weeks and one year.
• If purchased via your company, premiums are often treated as a business expense (subject to HMRC rules).
• An executive policy can cover up to 70–80% of your income, including dividends.
• Personally funded policies typically cover around 50–60% of income.
• You can often include a partner’s income if they are a co-shareholder.
• You can protect your income until retirement age.
• If you cancel your policy, there is no payout (no surrender value).

For a broader view of contractor insurance, see what insurance IT contractors need and professional indemnity cover.

What is covered by an IP policy, and what is excluded?

Most illnesses and injuries are covered by an income protection policy, although the precise terms vary between insurers.

Some exclusions typically apply, including self-inflicted injuries and conditions linked to drug or alcohol misuse.

If you have any pre-existing medical conditions, these must be disclosed during the application process.

Importantly, income protection covers inability to work due to illness or injury. It does not provide redundancy cover if a contract ends.

What is your insurer’s definition of incapacity?

One of the most important differences between policies is how incapacity is defined.

• Own occupation – you are unable to carry out your specific role (e.g. IT contractor).
• Suited occupation – you cannot perform your current role but could work in a similar capacity.
• Any occupation – you are expected to work in any role you are capable of.

For most contractors, own occupation cover offers the strongest protection. If you cannot carry out your specialist role, the insurer cannot require you to take on different work.

What is the tax treatment of an income protection policy?

There are two main ways to fund an income protection policy: via your limited company or personally.

If the company pays the premiums

If you take out a policy via your own limited company, premiums are often treated as a legitimate business expense. This means they may reduce your corporation tax bill.

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In most cases, the premiums are not treated as a benefit in kind.

However, if a claim is paid, the income is received by the company and taxed in the normal way.

If you take out an individual policy

If you take out a policy personally, premiums are paid from post-tax income.

Any claim payments you receive are usually tax-free.

Choosing between these approaches often depends on how you structure your income. See tax-efficient salary planning and dividend strategies for more context.

For a deeper explanation, see Income Protection Help.

How much does contractor income protection cost?

A wide range of factors affect the cost of a policy, including:

• The level of cover required
• The length of the payout period
• Whether premiums are guaranteed or reviewable
• Whether cover is index-linked or level
• Whether premiums are waived during a claim
• Your age and health
• Your occupation and perceived risk
• Your chosen retirement age
• The definition of incapacity
• Whether you smoke
• The insurer’s underwriting approach

How do you submit a claim?

1. Contact your insurer’s claims department.
2. Provide medical and financial evidence (e.g. GP or consultant reports).
3. The insurer assesses the claim and begins payments if accepted.
4. Payments continue until recovery, retirement or the end of the policy term.

Always use a contractor specialist

According to the ABI, around 85% of income protection claims are accepted.

While this is a strong acceptance rate, it still means a proportion of claims are declined.

For this reason, it is sensible to speak with a specialist adviser who understands contractor income structures and can ensure the policy reflects your actual earnings.

You may also want to consider related protection such as relevant life insurance and contractor income protection options.