KEY PERSON
INSURANCE
Key person insurance provides capital to a business should a key employee die or become seriously ill. The money can be used to compensate loss of profit, recruitment costs, replacement staff, or loan repayments.
Capital for your business if a key individual dies or becomes seriously ill
What Is key man Insurance? More often called key person insurance, it's a life insurance or critical illness policy that a business purchases on the life of an owner, a top executive, or another key employee considered critical to the business. The business is the beneficiary of the policy and pays the premiums.
IS KEY PERSON INSURANCE ALLOWABLE FOR TAX?
Key person insurance is taken out by a company or business on an individual within the business. The business, therefore, owns the policy and will be the beneficiary of any proceeds after a claim. The premiums are paid by the business and are usually tax deductible as long as the reasons for the cover, term and benefit amount fit certain criteria, and the insured is an employee.
HOW CAN KEY PERSON INSURANCE HELP?
Key person insurance protects your business from the loss of a key employee due to death or critical illness. It pays out a cash lump sum into the business helping it to cope with any disruption from losing an employee. It can help with the following:
RECRUITMENT
The Society for Human Research Management estimates that the cost of directly replacing an employee can run as high as 50 to 60 percent of their annual salary.
PROTECT LOST
PROFITS
One of the reasons a business invests in key person insurance is to provide protection against loss of profit resulting from the death or critical illness of a key employee. In this case, as the purpose of the cover is wholly and exclusively for the benefit of the business, tax relief on the premiums is allowable.
repay outstading
loans
What problems would arise if you lost a key employee or director/ owner due to serious illness or death?
Does your business have enough working capital to repay loans or finance without the support of this key individual? If the key person is an owner, will loans be called in?
In this scenario, capital to repay debt is not an allowable business expense.
raising finance for GROWTH
What difficulties would the business face in securing finance, given that lenders could lose confidence, knowing that a key person no longer provides a history of security.
HOW IS KEY PERSON INSURANCE TAXED BY HMRC?
Conclusively, how HMRC applies taxation policy on key person insurance is governed by the intention of the policy and who will gain the benefits. The mandate can be complex and can seem somewhat authoritarian as they rely on how the business proposes to benefit from the policy.
Typically, the proceeds are received by the business tax free but are treated as a trading receipt which means there may be tax to pay on any profits at the end of the businesses accounting period.
The premiums for the policy are tax deductible provided the reason for the cover and who is being covered meet specific criteria.
If the proceeds of any benefit are being used to repay a loan, the premiums will not be tax deductible as they are not wholly and exclusively for the benefit of the business but also benefit the lender. That said, the benefit will be free of tax as it is being used to repay a capital sum and is treated as a capital receipt.
If taxation of the proceeds is a concern, it's relatively easy to "gross up" the benefit amount.
Grossing up is an additional amount of money added to the benefit to cover the income taxes you may owe on the payout from an insurer. This requires insuring yourself for a larger sum than you require so you’re left with the correct payout after tax.
HMRC, KEY PERSON INSURANCE & TAX
The way in which HMRC taxes Key Person Insurance is elaborate. It’s regulated predominantly by a series of principles settled over seventy years ago known as the Anderson Rules.
One of these requirements is the ‘wholly and exclusively test‘. This serves as one of the dominant components that determines if you'll pay tax on Key person Insurance premiums.
The assessment explores if the payout from the insurance will be ‘wholly and exclusively for the purposes of the company’s trade’, i.e. exclusively for the help of the company. If so, premiums are generally a tax-deductible business expense against the company’s corporation tax bill.
If you are concerned or unsure about the taxation of both benefits and premiums, or whether you need to consider key person cover, please get in touch.