Income Protection vs. Key Person Insurance: Which Do I Need?

By September 23, 2019Pensions

At a glance, Income Protection and Key Person Insurance might look like the same thing. After all, they both intend to help protect a business if someone falls seriously ill or is injured; although the latter safeguards against death, as well.

In broad terms, Key Person Insurance is designed to protect a company’s financial interests. Income Protection, however, is intended to look after an individual and their family (i.e. following a serious injury or diagnosis of illness, which prohibits the person from working).

In this short guide, we have provided a summary of the key similarities and differences between Income Protection and Key Person Insurance. We’ll also be suggesting some scenarios where either might be appropriate to consider.

Key Person Insurance

If you are a Director or an important stakeholder in a particular business, then you will likely want to consider the benefits of Key Person Insurance. Essentially, it is a type of insurance which helps to ensure the business has access to much-needed funds if a key person, shareholder or decision-maker dies.

Some insurance policies will offer Critical Illness Cover (CIC), which could provide an emergency lump sum to the business if a key person can suddenly no longer work due to certain illnesses or injuries. If you are considering adding CIC to a Key Person Insurance policy, then it is important to check the details carefully with one of our Financial Planners. Certain illnesses and injuries might not be covered under different policies. You might need to balance the premiums of the policy with its conditions, as comprehensive policies are likely to be more costly.

Please speak to us about the tax implications of a Key Person Insurance policy. For instance, if you take out a policy for “business continuity purposes” then you should be able to treat the insurance premiums as a tax-deductible business expense. If, however, you are thinking about using Key Person Insurance to protect a loan, then the policy will likely not qualify as “tax-deductible”.

Key Person Insurance can be used to achieve a range of goals, including:

    Repay loans which might need settling.
    Providing funds to help close the business in a methodical, non-chaotic way.
    Open up a financial “safety net” to mitigate against a possible loss of profits.
    Supply funds for staff training and recruitment purposes.
    Provide much-needed funds for projects and developments.

Income Protection

As mentioned above, Income Protection exists primarily to protect an individual and their family, should they find themselves no longer able to work due to injury or illness. Should this, unfortunately, happen to you, and you have taken out such a policy, then if you meet its conditions you should be entitled to up to 80% of your pre-incapacity salary.

Sometimes a business will pay for an employee’s policy (e.g. a Company Director). In which case, this is usually called “Executive Income Protection” or EIP. Similar to Key Person Insurance, EIP can be treated as a tax-deductible business expense.

It’s worth noting, however, that if the policy’s conditions are met then the benefits are paid directly to the business, not to the individual. This means that when the company then distributes this post-incapacity, replacement remuneration to the employee, it will be subject to tax. So, it’s worth running this by us to ascertain the best way to distribute this in a tax-efficient manner.

In many cases, an individual will simply take out a policy themselves rather than a business taking it out on their behalf. Income Protection can be an attractive option for self-employed people, who typically do not otherwise have a means of attaining “sick pay” (since they have no employer to pay it).

Bear in mind that these self-funded policies are not tax-deductible, since you will likely be paying for the premiums using post-tax income. The good news, however, is that the benefits you receive from the Income Protection policy are usually exempt from tax.

Final Thoughts

Many businesses recognise the value of certain types of insurance to protect their assets and future growth prospects. Public Liability Insurance, for instance, is crucial for protecting your business against compensation claims levelled against you by customers. Employers’ Liability Insurance will help to cover you if such claims emanate from your staff.

However, as many as 3/5 small businesses in the UK admit to having no succession plan. Nearly 90% of the UK’s registered companies comprise businesses which employ fewer than 5 people, which are especially vulnerable if a key person was suddenly removed from the picture. This vulnerability, in turn, can hold businesses back due to investor reluctance or maintaining lines of credit.

If you are considering Key Person Insurance or Income Protection as a possible solution to your needs, then act swiftly. According to the ONS, a 35-year-old man has a 1/62 chance of dying within the next ten years. By the age 45, the chances change to 1/29 and by age 55, the chances are 1/12.

At FAS, we offer financial planning and advice on a wide range of business and income protection solutions. If you are interested in exploring your options, please do give us a call.