A small company can depend on one or two people. That person may be the one who wins the work, the one who does it, or the one the bank and the main customers deal with.
The question is what happens if that person is off for a year.
The company takes out and pays for a policy on that person’s life, and can include critical illness as well. If they die or are diagnosed with a covered illness, the policy pays the company.
The money can cover wages while revenue falls, pay for recruitment, service borrowing, or fund an orderly sale of the business.
The key person is not always the owner.
The person who brings in most of the work, or holds the relationships that do.
The only person with a licence, accreditation or technical qualification the business trades on.
The person the bank, the main customer or the main supplier deals with.
Anyone whose departure would breach a contract, a covenant or a funding condition.
The test is what would stop if this person were unavailable for six months, and what that would cost.
There is no set formula. The amount is built up from these questions:
The company in this example is made up. It has turnover of £1.2 million and depends on one director to win and deliver most of its work. If half of that revenue were lost for a year, the company would be short £600,000 of sales. It would also face a recruitment fee and six months of a replacement’s salary before that person was productive.
The company in the example is made up
Those are the figures a financial adviser would start from. The amount of cover is a regulated advice question.
They are separate policies. A business can need all three.
Whether premiums are deductible for the company, and whether a payout is taxable, depends on the purpose of the policy and who benefits. Cover taken out to protect profits is treated differently from cover taken out to repay a loan or to buy shares (HMRC Business Income Manual BIM45525).
HMRC allows the deduction where the policy is short-term cover taken out solely to protect the company against loss of profits from losing the person, and the payout is then taxed as a trading receipt. Cover taken out to repay a loan or to buy shares is treated differently (BIM45525).
Where the premiums were deductible, the payout is normally taxed as a trading receipt. Where they were not, it normally is not. The treatment follows how the policy was set up, and is difficult to change afterwards.
A lender can make it a condition of a loan. The policy is then assigned to the lender, and the payout goes to them.
Shareholder protection funds the purchase of the shares. It pays the company nothing towards the loss of the person’s work. Whether both are needed is a question for a financial adviser.
This sheet explains how the rules work. It is not advice, and it does not take your circumstances into account. Your accountant can talk it through with you and can introduce you to a regulated financial adviser.