More and more small businesses are becoming aware and making full use of the tax advantages of relevant life insurance. Taking out insurance policies may not be at the forefront of your mind when it comes to running a business (with the exception of those you are legally required to have it such as employer’s liability insurance or motor insurance), but relevant life insurance should be considered for the tax benefits as well as part of protecting loved ones.
What is relevant life insurance?
Relevant life insurance is a relatively new business protection product. It gives small business owners similar benefits to those afforded by larger companies with group life scheme policies. Group life schemes are typically only accessible to companies with five or more employees and offer those with the cover the benefit of a lump sum payment to their family or dependents should they die during the course of their employment.
Relevant life insurance works in a similar way, however, it has a number of differences. Firstly, it is designed for much smaller businesses and in fact, is most popular with solo directors of their own limited company, although it can still be offered to employees. Secondly, unlike with group life schemes, it is the company that pays for the policy as opposed to the employees who will benefit from it. Finally, pay-outs from relevant life insurance policies do not count towards the annual lifetime pension allowance. This is beneficial to higher earners as, were they to receive a pay out from a group life scheme which does count towards the annual lifetime pension allowance, they would incur a tax bill should the combined total go over the allowance.
How does relevant life insurance work?
Relevant life insurance works in much the same way as traditional life insurance. You take out a relevant life insurance policy through your limited company and choose to cover yourself as the director and/or any employees. Should someone who is covered die whilst the policy remains in place, the insurance will pay out a lump sum to the individual’s beneficiaries through a discretionary trust. Usually, their family or dependents are the beneficiaries as well as being named as the trustees.
What is a discretionary trust and how does it work?
A discretionary trust is a legal arrangement that allows the owner of a life policy (known as the settlor) to give control of their policy to a person or group of people (referred to as trustees). The trustees look after the policy, and should a time come where a pay out from the policy is due to be issued, the trustees are able to access the policy and transfer the pay out to beneficiaries – which are a chosen group of people decided by the settlor. The trustees have the discretion to decide which of the beneficiaries will receive the trust fund, how much and when. When a life policy is looked after in this way, it is said to be ‘in trust’.
Using a discretionary trust for a life policy has practical and financial benefits including:
- Save on inheritance tax. Any money that is paid out from a life policy does not fall into a deceased’s estate which means inheritance tax does not need to be deducted from it before passing it onto the beneficiary.
- Faster pay out. As the trust fund is held separately from your estate it means that it can be transferred to beneficiaries quickly. In order to transfer any assets from your estate, a deceased’s personal representatives must obtain probate so that they have the authority to deal with your estate. In England and Wales either a ‘grant of probate’ or ‘grant of letters of administration’ is issued to your personal representatives. This process takes time and if you die without having made a will it takes even longer. Since the trustees are the owners of a policy placed in trust, they do not have to go through this process to make a claim.
- Control your funds. By placing your policy in a trust, you can choose specifically who you want the proceeds to be paid to and when. This can be useful if you choose to elect your children as beneficiaries as you can ask the trustees to ensure they have adequate financial support up until they are 18 before they gain full access to the rest of the trust fund.
Who pays for relevant life insurance?
Relevant life insurance is paid for by the employer. It is suitable for a range of different business structures such as limited companies, partnerships, charities and other structures where there is an employer/employee relationship. Relevant life insurance cannot be taken out if you are a sole trader. The benefit from the policy is paid out to the employee’s chosen beneficiaries and not to the company – which means the benefit is to the employee and not to the company.
What are the tax advantages of relevant life insurance?
Small business owners are choosing to take out relevant life insurance because there are more tax saving advantages than with personal life insurance policies – which are taken outside of the business:
- Relevant life insurance is not considered a P11D benefit in kind. With many other business perks or benefits, there is usually income tax to be paid by the employee who is receiving it and national insurance (NI) to be paid by the employer who is providing it. However, you could provide relevant life insurance cover for yourself as the director of your own company or to an employee and no income tax or NI would have to be paid on the value of the cover.
- The premiums are tax deductible for the company. As the company pays for the relevant life insurance policy it can be treated as an allowable expense. This means that the cost of it can be deducted from your profit before corporation tax is calculated and will help reduce your corporation tax bill.
How much does relevant life insurance cost?
The cost of relevant life insurance will vary depending on several factors, some of which you’ll have control over and others you won’t:
- The amount of cover you would like
- The length of the policy (can’t exceed age 75)
- Sate of employees’ health
- The age of employees
- If the employees smoke
- Lifestyle of employees
- Family health history
An example of prices would be:
30 year old non-smoker, applying for £500,000 of cover until age 65 = £19 p/m
40 year old non-smoker, applying for £500,000 of cover until age 65 = £32 p/m
50 year old non-smoker, applying for £500,000 of cover until age 65 = £55 p/m
These prices are just for illustrative purposes and the actual prices people pay will be different being based on the level of cover they opt for, their age and medical history.
How long does it take for relevant life insurance to pay out to beneficiaries?
Pay out times do vary but are usually paid between 30 to 60 days from death of the policy holder. As the money is paid into a trust and not the estate of the deceased the money is available immediately as they do not have to wait for probate to be granted.
Does the beneficiary have to pay tax on this amount?
One of the significant tax advantages as explained above is that, because the relevant life insurance is held in a trust, any money paid out to beneficiaries falls outside of the deceased’s estate. This means that there is no inheritance tax to pay which would be charged at a rate of 40%.
Pay outs are however instead treated as income, so beneficiaries will have to pay income tax on the amount they receive. It is important to consider if any pay outs will result in the beneficiary being pushed into higher income brackets as this could result in a larger tax bill than expected. One way around this is to control how much money is taken out from the trust as there is nothing stopping beneficiaries from taking a portion at a time each tax year to remain as tax efficient as possible.
How can you buy Relevant Life Insurance?
Like other forms of business protection insurance, relevant life insurance can only be purchased via a specialist intermediary. This article has been written in partnership with the team at Business Protection Hub, which can help you review your options, compare the market and allow you to make the best decision.
Disclaimer: While the information in this article is based on our understanding and will apply to most small businesses, you should always seek professional and personalised financial advice before taking out a policy.