Key Man Insurance Taxation
What is Key Man Insurance Taxation?
The tax treatment of Key Man Insurance is not absolute or straight forward for every company. There are numerous reasons why individual companies are treated differently by HM revenue and customs. Your accountant will be able to give you a clear picture of how your business will be affected. It’s also important to make sure that you are using the most up to date tax legislation.
Key man insurance is taken out by a company on an individual within the company. The company therefore owns the policy and will be the beneficiary of any claim. If the companies reason for insurance sits within the designated reason below, it is a deductible business expense, and is therefore tax deductible. However if there is any reason why the insurance is not solely for the businesses benefit, it is no longer deductible.
The main principles of Key Person taxation were set by the 1944 Chancellor of the Exchequer, John Anderson. In answer to a parliamentary question he made the following statement:
“Treatment for taxation purposes would depend upon the facts of the particular case and it rests with the assessing authorities and the Commissioners on appeal, if necessary, to determine the liability by reference to these facts. I am, however, advised that the general practice in dealing with insurances on the lives of employees is to treat the premiums as admissible deductions, and any sums received under a policy as trading receipts, if (i) the sole relationship is that of employer and employee; (ii) the insurance is intended to meet loss of profit resulting from the loss of services of the employee; and (iii) it is an annual or short term insurance. Cases of premiums paid by companies to insure the lives of Directors are dealt with on similar lines.”
If the company is taking out a policy on its employee, to protect the business from a loss of profits resulting from the loss of that key employee and the insurance policy is annual or short term, the company may be allowed tax relief on the premium. However if the key employee owns more than a 10% share in the company, it is no longer an allowable expense. This is because the insurance policy is no longer seen as being solely for the business.
HMRC also stated the below:
“An employer may take out in his own favour a policy insuring against loss of profits resulting from the death, critical illness, sickness, accident or injury of an employee, director or other ‘key person’.”
Premiums on a Key Person policy will be allowable if all the following conditions are met:
- The only reason of the Key Person Insurance is the purpose of replacing a loss of income resulting from a loss of works from the key person. But not including a capital loss to the company.
- Insurance must be term insurance providing cover for their person or person’s only during the term of the policy and only while the person is working for the employer.
Therefore a whole of life insurance would not qualify as tax deductible as the policy will last longer than the person’s usefulness to the company. A whole of life insurance policy is more suitable as shareholder protection because the person may hold on to the shares even after leaving the company. However this is unlikely to qualify for tax relief.
If tax relief has been allowed on premiums then the proceeds, the pay out amount, can be taxed. But it is important to note that tax treatment of proceeds of benefit will be treated differently depending on the judgement of the local tax inspector. When taking out a policy it may be wise to include a certain amount or percentage of benefit, to cover any tax liability from the pay-out. This is to guarantee that the pay out meets the company needs.
Key Man Insurance FAQ’S
What is Key Man Insurance?
Key Man Insurance helps safeguard a business against the financial effects of a critical illness, a terminal illness or from the death of one of the businesses key people. A ‘Key Man’ is an employee whose death or continued absence would affect the profits and the running of the business. The loss of an integral employee or director may result in: reduced sales, a loss of profits/turnover, wasted time, recruitment costs, the disruption of development plans and increased workloads for the remaining staff. Keyman Insurance is a life insurance policy, which can have critical illness added. It is written on the life of a key business employee, but it is owned by the business. If something should happen to that person, the policy is paid out directly to the business, or this reason the business pays the premiums. Find out more about how Key Man Insurance is treated as a tax deductible business expense.
Can you change who owns the policy?
Yes, you can change who owns the insurance policy through a “deed of ownership”, however these must be written through a solicitor. You may need to change the owner of the policy if your company ceases trading or if it changes name. There is also the option of transfer the policy to a personal cover although this happen very rarely.
Who can take out a Keyman policy?
A Keyman Policy can be taken out by a limited company or by sole traders as a “life of another” policy, however in this case the person taking out the insurance must have a financial association with the life being insured.
How much does Key Man Insurance cost?
The cost is dependent on the life assured age, smoker status amount of cover and term. Once a policy is submitted to the underwriter it can be either accepted on standard rates, loaded, with an exclusion, postponed or declined. So you will not know the exact price of the policy until you have terms issued.
Is the Key Man Insurance policy owned by the business?
Yes. The policy is taken out by the business to cover the life of an employee and so is owned by the business. The business is the beneficiary of any claim which is made, however the pay-out amount can be used for any reason. This can include payment of staff or covering any profits which may be lost.
What are exclusions and underwriters?
An underwriter works for the insurance provider, they look at your details, family history and health issues and attribute you a risk factor based on how likely you are to develop certain illnesses. If you are seen as high risk they can increase your insurance premiums. They may also add an exclusion. An exclusion is when the policy includes a clause not to cover the policy holder for a certain condition, this normally applies to Critical Illness Cover. For example someone may be excluded for cancer if they have previously had any form of cancer. Policies can also occasionally be postponed if the underwriter wants to wait for further evidence or for cool off periods since a previous health issue.
How long can it take to set up Keyman Insurance policy?
This can vary from same day to a few weeks. Once you have decided to go ahead the Keyman Cover application only takes around 15 minutes, the application is then submitted to the underwriter which can be accepted instantly. If you are happy with the terms offered we can start the policy. If the underwriter wants further evidence, such as a copy of your GP report it will take longer. GP’s have been known to take months to return a report, but in most cases it’s just a few weeks. Once the underwriter has all the information needed its normally only takes about 48 hours to get an underwriting decision.
Does my company have to be based in the UK to be able to take out Key Person cover?
The owner of the policy has to be a UK company, although the lives of the insured do not have to reside in the UK.
Can a Limited Liability Partnership have a Key Person Insurance policy?
Yes limited liability partnerships and limited companies are both able to take out Keyman insurance, they both handled in the same way.
How much should I insure a key person for?
This is dependent on the company and the reason for insuring that individual. It can be to cover a loan or investment amount, or it can be dependent on working out the worth of the person to the company. Think about loss of profits, cost of replacement and debts that would need to be covered to keep the company running without that person.
Is Key Man Insurance a tax decutible expense?
Yes it can be a deductible expense however this is dependent on a range of factors including current tax legislation along with the reason for insurance and the amount the cover is for. Please take a look at our page on key man insurance taxation for further details on this
How long should we insure our key person for?
This really depends on how long you think you will need the policy. If you believe the person you are insuring will be at your company for 10 years, and will continue to be a valuable asset then you should take out a 10 year guaranteed premium. Taking out a shorter premium may mean having to renew the policy, this can cause additional expense, as the person being insured will be older and may have suffered medical issues. Taking out a longer term premium guarantees the lower rate. You can cancel these policies at any time without penalty so there is no risk of being stuck with a policy if that person leaves the company.
Can critical illness cover be added to a Key Man Insurance policy?
Yes critical illness can be added to any Key Man Insurance policy. Any premium on a successful claim and will be paid to the company, and the company will be the owner of the policy.
Is a medical essential?
This depends on a number of factors including age, the amount of cover you would like and past health. Sometimes a medical is triggered when the amount is above £500,000 but this is not always the case.
Can a medical be carried out at home?
Yes in some cases this is possible. We always try and make sure the medical is arranged to your convenience however it’s not always possible to have the medical at home.