If you are a limited company contractor, you won’t receive any of the ‘perks’ associated with being an ’employee’.
You only get paid while you’re working. So what happens if you’re unable to work due to illness or injury?
Employees usually continue to get paid while off-sick.
As a contractor, you must consider if your savings alone will see you through some time away from your contract duties.
According to a leading insurer, LV, a mere 6% of ‘self employed’ people have an income protection policy in place.
This is where the concept of income protection comes in.
If you invest in an IP policy, you will have a safeguard to protect you in the event of falling ill and being unable to work as a result of the illness or injury.
This type of policy will pay you a monthly income while you’re ill, and they tend to be very reasonably priced.
What’s in this guide?
Here we take a look at how income protection works, and which factors affect the premium you’ll have to pay. We also answer some frequently asked questions.
- How does income protection work for contractors?
- What is the tax treatment of income protection premiums?
- How much does this type of policy cost?
- Things to consider before taking out a policy.
- What income protection insurance doesn’t cover.
- Get a quote from our partner, Broadbench.
Contractor income protection – how does it work?
An IP policy pays you a pre-agreed monthly payment while you’re off sick, and even until retirement if you’re seriously ill.
The amount of benefit you receive depends on your contract income, and the ‘deferred period’ (the length of time before the policy starts to pay out) you choose.
You can select the waiting period that suits you – usually somewhere between four weeks and a year.
Some policies will cover you from day one of an accident or illness which is ideal if you don’t have any savings to fall back on.
You can typically cover yourself for up to 70% of your current contract income if you pay for the cover through your limited company (see below).
The percentage falls to around 55% if you pay for the cover personally, out of your post-tax income.
Tax treatment of income protection policies
You can choose to pay for your income protection policy either as an individual or via your limited company.
If you pay personally, you do so with post-tax income. Any funds received via a claim are tax-free.
What if your limited company takes out a policy to protect a director?
The executive income protection policy premiums are usually an allowable business expense, and therefore deductible against Corporation Tax.
Importantly, the cost of the premiums is not considered a ‘benefit in kind’ by HMRC, so neither the company nor the director are taxed on this benefit. You don’t need to report the premiums on your annual P11d form.
However, the tax position is reversed if your company makes a claim.
If your limited company makes a claim, it has to pay tax on payments made via the policy if it’s an executive policy.
The policy income is treated the same way as any other trading income. Directors are free to distribute this income in the same way as contract income.
How much does income protection cost?
Many factors affect the cost of income protection premiums, including:
- How much cover you want – typically between 50 and 70% of your current income.
- The type of premium (fixed price, indexed linked, etc.)
- Claims history
- Age of applicant – premiums increase with age.
- Pre-existing health conditions.
- If you smoke – costs can almost double, on average, if you’re a smoker.
- Your occupation – usually one of four tiers used by insurers. The riskier the occupation, the higher the cost.
- The policy payout length – usually as long as you’re ill, the term expires, or the applicant dies.
- Any ‘risky’ hobbies you have – do you enjoy skydiving?
- Waiver of premium – if your payments are suspended if you’re not able to work.
Things to consider before signing up
Use a contractor specialist
Ideally, you should use a provider that has experience in the contracting market, and how contractors operate. You don’t want to get caught out by hidden exclusions or deal with a broker who doesn’t understand how contractors operate.
Make sure dividends count as income
Make sure that dividends are included in any calculations, as they make up the bulk of most limited company contractors’ income.
Some providers consider dividends to be ‘investment income’, rather than traditional income such as a salary.
Cover may also include a spouse’s earnings where the incapacity of the main fee earner reduces or stops the spouse’s earnings from the company.
This reinforces the importance of working with a contractor-specialist broker.
Look at the claims history of the provider
Make sure any income protection providers you compare have good records of dealing with and meeting past claims.
According to the ABI, around 85% of nationwide income protection claims were successful in 2022-3.
Your financial adviser will be able to help you access this data.
Make sure your occupation is stated explicitly
Your policy should specifically state that it will pay out if you’re unable to carry out your specific occupation (as a contractor). This is known as own occupation cover.
If this isn’t stated, the provider may insist that you’re still able to carry out a different type of work, even if you’re unable to perform your contract duties.
Suited occupation definition assumes you can return to work in a similar, but not identical role.
Any occupation cover means you are expected to return to a wide variety of roles, not necessarily the contract role you last held.
Cover yourself until retirement
Make sure your policy covers you until you plan to retire. For obvious reasons, the older you are when the plan ceases, the higher the cost. Most insurers won’t insure you beyond the age of 70.
Is your policy inflation-proofed?
Many contractor specialists suggest that your best option is to choose index-linked premiums. This means that your premiums are linked to inflation – usually the RPI.
A non indexed-linked policy will have the same payout over time, and won’t increase.
Income protection vs. critical illness
Income protection provides a regular income if you’re unable to work.
Critical illness cover doesn’t have a deferral period and pays out a single lump sum upon diagnosis of a critical health condition.
You can read more in this dedicated guide.
What Income Protection does not cover
Income Protection Insurance covers most illnesses and injuries that stop you from working either in the short or long term.
Insurers typically exclude claims made due to drug misuse, self-harm, or as a result of travel to an ‘unstable’ country or region.
It is not a ‘business’ insurance policy to cover the costs of having a contract terminated, i.e. loss of contract insurance.
This is a common misconception of this type of cover.
Find out more about Income Protection
Get in touch with our IFA partner, Broadbench, to find out more or to get some policy quotes. We’ve worked with Broadbench for over 5 years – they’re contractor specialists with excellent customer service.