Executive income protection: How limited company directors can protect their earnings
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For many limited company directors, the business depends heavily on their ability to keep working.
That can make illness or injury a bigger financial risk than it first appears.
A director may have a profitable company, regular clients and cash in the bank, but if they are the main fee earner, a prolonged absence can affect both the business and their personal income at the same time.
Executive income protection is designed for exactly this situation.
Instead of the director buying a personal policy from their own post-tax income, the limited company takes out the cover and pays the premiums.
If the director cannot work because of illness or injury and the claim is accepted, the insurer pays the benefit to the company. The company can then use that money to continue paying the director.
Why directors use executive income protection
A typical owner-director does not always receive all of their income as salary.
Many take a relatively modest salary and extract the rest through dividends. That can make standard employee benefits less straightforward, particularly where there is no larger employer providing sick pay.
Executive income protection gives the company a way to insure against the loss of that director’s working capacity.
For example, take a director whose normal personal income is around £4,000 per month.
If illness prevents them from working for six months, they may need £24,000 simply to maintain their usual household income.
If the business also loses revenue while they are away, drawing that money directly from company reserves can become much harder.
A suitable executive income protection policy can help bridge that gap.
The company pays for the policy
One of the main attractions is that the company normally pays the premiums.
That can be more efficient than the director taking additional income from the company, paying personal tax on it and then using the remaining money to fund a personal policy.
The precise tax treatment depends on how the policy is arranged and the circumstances of the business, so directors should not assume that every premium will automatically qualify for Corporation Tax relief.
The benefit also needs to be understood correctly.
The insurer normally pays the company, not the director personally. The company then continues to remunerate the director, with the usual PAYE and tax treatment applying to those payments.
A fuller guide to income protection for limited company directors explains how company-funded and personal arrangements differ.
How much income can be covered?
Insurers will normally place limits on the level of benefit available.
They may look at salary, dividends and other earnings when deciding how much can be insured, although the treatment of dividends varies between providers.
That point matters for owner-managed companies.
A director taking a salary of £12,000 or £15,000 but receiving a much larger amount through dividends would usually want the insurer to take account of the wider remuneration package where the policy allows it.
There may also be scope to cover employer pension contributions and some employment costs, depending on the policy.
The maximum benefit should therefore be checked at the outset rather than assumed.
The deferred period makes a big difference
Executive income protection does not normally start paying from day one.
The policy will have a deferred period, which could be four weeks, eight weeks, 13 weeks, 26 weeks or longer.
A company with strong cash reserves may be comfortable funding the first three or six months itself and choosing a longer deferred period.
A small consultancy where income stops almost immediately when the director stops working may need payments to begin sooner.
The longer the deferred period, the lower the premium will usually be, so there is a balance between cost and how much short-term risk the company is willing to retain.
Own occupation cover is important
Directors should also look carefully at how the policy defines incapacity.
An own-occupation definition generally means the insurer considers whether the director can perform their actual job.
That can be particularly important for consultants, IT professionals, engineers and other specialists.
Someone might technically be capable of doing some form of work while still being unable to perform the occupation that generates their normal income.
The wording varies between insurers, so this is one part of the policy where the detail matters.
Cover can run for years
Executive income protection is designed for long-term absence, not simply a few days off work.
Some policies pay a benefit for a fixed period, perhaps one or two years for each claim.
Others can continue paying until the director returns to work or reaches the policy end age, provided the claim continues to meet the insurer’s terms.
That distinction can become very important where illness lasts several years.
A business owner choosing between policies should therefore look beyond the monthly premium and check the maximum claim period, deferred period and incapacity definition.
Who is it most useful for?
Executive income protection is particularly relevant where the company relies on one or two directors to generate most of its income.
That includes consultants, contractors, agency owners, accountants, designers, engineers and other professionals running small limited companies.
It can also be useful where the director has significant personal commitments such as a mortgage, school fees or other regular household costs that would become difficult to meet if income stopped.
The recently launched Income Protection Help focuses specifically on these issues, including executive income protection for company directors and the way policies can be structured through a limited company.
For most directors, the useful starting point is not the insurance itself.
It is working out how long the household and the business could cope if the director could not work.
Once that number is clear, it becomes much easier to decide whether executive income protection is worth considering and what level of cover would actually be useful.