INSURANCE - 11.11.2011

Replacing your income in times of trouble

Life or death statistics

According to insurance industry figures, more people have a policy to cover premature death than a long-term illness which prevents them from working. This fact flies in the face of other statistics which show that you’re more likely to fall long-term ill than die before you reach retirement. Illness might not be a major problem for your employees as they can rely to some degree on Statutory Sick Pay. But as a director this is unlikely to meet your needs. What other options do you have?

Low payout

The usual way to boost income during periods of long-term illness is by individual income replacement plans (IRPs). These are usually taken out by or for individuals and typically pay a maximum of around 80% of the usual net pay based on your regular income. But they don’t take account of benefits-in-kind (BiKs), such as a company car, or other forms of income you take from your company like dividends. So where, to achieve maximum tax efficiency, you’ve set your salary at a low level and top this up with dividends and benefits, a standard IRP isn’t going to provide you with the sort of cash you need to survive.

Executive income replacement

As an alternative to a standard IRP you could go for an “executive income replacement plan” (EIRP). These are intended to be taken out by the company in favour of a named individual, usually a director or senior manager. EIRPs can replace earnings at much higher levels than IRPs. £300,000 per annum is typical. Plus, importantly, they can also cover the value of BiKs such as company cars as well as dividends and interest.

Tip. Where a director/shareholder is the sole income generator, an EIRP can compensate for all the dividends the company pays even where some of these go to the director’s spouse. This can be useful where you’ve split the shareholding with your other half as part of a tax-saving strategy.

Calculating the payout

Insurance companies use a formula to work out how much the policy will pay if you make a claim. Taking an average of three years’ income is typical and designed to stop manipulation of earnings to boost the payout. You should be as accurate as possible when entering details of your income on an EIRP application as the premium will be based on this. The higher the income covered, the greater the premium will be. But when you make a claim on the policy the formula will base the payout on your actual income and not the amount shown in your application.

Who gets the money?

If you make a claim on an EIRP, the money will be paid to your company and counts as taxable income in its accounts. The company can use the cash to pay salary, dividends etc. to you. These again will be taxed as they would have been if the money etc. had been paid out of your company’s normal profits.

For information on companies offering EIRPs, visit http://companydirector.indicator.co.uk (CD 13.04.04).