Key Person Insurance

Financial Protection for Your Business if a Key Individual Passes Away or Becomes Seriously Ill

Often referred to as key person insurance, this is a life insurance or critical illness policy that a business secures on the life of an owner, senior executive, or other crucial employees who are vital to the company’s operations. The business serves as the policy’s beneficiary and is responsible for paying the premiums.

Is Key Person Insurance Tax-Deductible?

Key Person Insurance is a policy that a company or business takes out on an individual within the organisation. As the policy owner, the business is the beneficiary of any payout in the event of a claim. The business covers the premium payments, which are generally tax-deductible, provided that the purpose of the coverage, the policy term, and the benefit amount meet specific criteria, and the insured individual is an employee.

How Can Key Person Insurance Benefit Your Business?

Key Person Insurance safeguards your business against the loss of a crucial employee due to death or critical illness. It provides a cash lump sum to the business, helping to manage the disruption caused by the employee’s absence. This insurance can assist with the following:

Key Features of Key Person Insurance

• Recruitment Costs: Replacing a vital employee can be costly. The Society for Human Resource Management estimates that the cost of replacing an employee can reach 50% to 60% of their annual salary. Key Person Insurance can provide the necessary funds to cover recruitment expenses, ensuring your business can find a suitable replacement without financial strain.

• Protecting Against Lost Profits: One of the primary benefits of Key Person Insurance is the financial protection it offers against potential profit losses due to the death or critical illness of a key employee. The payout can help stabilize the business during this challenging time. Additionally, since the insurance serves the exclusive benefit of the business, the premiums are typically eligible for tax relief.

• Repaying Outstanding Loans: If a key employee, director, or owner becomes seriously ill or passes away, your business might struggle to meet financial obligations such as loan repayments. Key Person Insurance can provide the necessary capital to keep up with these payments, helping to maintain the business’s financial stability even in the absence of a critical team member.

• Raising Finance for Growth: The absence of a key person can shake lender confidence and make it more difficult for your business to secure financing for growth. Key Person Insurance can act as a safeguard, giving lenders reassurance that the business has a financial safety net in place, thereby improving your chances of raising capital when needed.

How Is Key Person Insurance Taxed by HMRC?

The taxation of Key Person Insurance by HMRC is ultimately determined by the policy’s purpose and who benefits from it. The rules can be complex and may seem stringent, as they depend on how the business intends to utilize the policy proceeds.

Typically, the proceeds received by the business are tax-free, but they are considered a trading receipt, meaning that any profits at the end of the business’s accounting period may be subject to tax.

The premiums for the policy are tax-deductible, provided the coverage purpose and the individual being insured meet specific criteria.

However, if the proceeds are intended to repay a loan, the premiums will not be tax-deductible since they are not used solely for the business's benefit but also serve the lender. That said, the benefit itself will be tax-free, as it is treated as a capital receipt used to repay a capital sum.

If there is a concern about taxation on the proceeds, it is relatively straightforward to "gross up" the benefit amount. Grossing up involves adding an additional amount to the insurance benefit to cover any income taxes that may be due on the payout. This means insuring yourself for a larger sum than initially required, ensuring that you receive the intended payout amount after taxes.

HMRC, Key Person Insurance & Taxation

The taxation of Key Person Insurance by HMRC is complex, largely governed by principles established over seventy years ago, commonly referred to as the Anderson Rules.

A key aspect of this taxation is the ‘wholly and exclusively test,’ which is one of the primary factors in determining whether you will need to pay tax on Key Person Insurance premiums.

This test evaluates whether the insurance payout will be used ‘wholly and exclusively for the purposes of the company’s trade,’ meaning solely for the benefit of the business. If this condition is met, the premiums are typically considered a tax-deductible business expense, reducing the company’s corporation tax liability.

If you have concerns or uncertainties about the taxation of both the benefits and premiums, or if you’re considering Key Person Insurance, please don’t hesitate to get in touch.