Key Person Insurance explained
For many businesses, there are key personnel who are important to the success of it, be it directors or employees.
If anything was to happen to these key people resulting in them having to take a leave of absence, the business could find its profits taking a tumble. This might be due to an accident, injury or critical illness or, even worse, the individual passing away.
Provided the policy is solely designed to protect the business against a loss of trading income, Key Person Insurance premiums are usually tax-deductible – although any future pay-out will likely be subject to Corporation Tax as a trading receipt.
When is Key Person Insurance tax-deductible?
For Key Person Insurance premiums to be tax deductible the following conditions have to be met:
- The sole purpose of the policy is to meet the loss of trading income which may arise as a result of the loss of services provided by that key person.
- If it is a life insurance policy, it must be a term insurance which should not extend beyond the period of the individual’s usefulness to the business
If the premiums are tax deductible then any resulting receipts from a subsequent claim will also be taxable.
If the business doesn’t claim a tax deduction for the premiums, HMRC still treats the payout as taxable as long as the policy meets those two conditions.
When is it NOT tax-deductible?
There will be key person insurance where the premiums are not tax deductible and therefore any pay outs derived from such a claim will not be taxable – this might include:
A whole of life policy: The premiums are paid into an endowment policy on the life of the key person which is tied to meeting future loan finance costs rather than the loss of trading profits.
A critical illness or accident policy: Where the premiums contribute to a capital investment.
A loan protection policy: Cover taken out purely to repay a business loan or protect loan security, rather than safeguard profit.
Cover for sole trader: Because a sole trader is the business, HMRC sees the policy as giving personal benefit, so it fails the test.
Cover for majority shareholders/directors: If the insured person owns most of the shares, HMRC may view the policy as protecting the personal value of their shareholding.
Our top tax tip for buying Key Person Insurance
Always read the policy terms before you commit to signing anything. Understanding all of the details upfront is the only way to know the true tax impact of the key person cover you’re about to take out.
If in doubt, give us a shout – we’ll be happy to discuss the tax implications surrounding any policy.
