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Limited cover

After identifying the keypeople in a limited company, how do you put insurance in place?

Over the past two weeks, I have been specifically looking at the business continuation needs of unincorporated businesses. So how about the typical and most often quoted business continuation scenario – the limited company? Well, if you read most articles and literature on the subject of business continuation/keyperson cover, you could be forgiven for thinking that this was the only business structure for whom this protection need was an issue.

In many private companies, you will no doubt find that the most important persons to cover will be the owner/ managers. That is not to say that there will never be other than owner/managers as keypersons, just that they will represent the biggest group in most SMEs. Having identified who the keypersons are by virtue of being satisfied that the financial consequences of their loss or absence from the business would cause a financial loss that would be significant, disruptive and not easy (or even possible) to cover out of ordinary cashflow without harming the business, how do you put the cover in place?

Well, as a separate legal entity, the company can definitely contract for the necessary policy which would then be held on the balance sheet as an asset. Using this so-called corporate route, the policy on the life of the keyperson would be effected by the company for its own benefit. No trust will be needed. Insurable interest would exist in the form of the financial loss that the company would anticipate suffering as a result of the death or serious illness of the life assured – the key director.

An alternative means of providing cover on the lives of the owner/managers is for the individual directors each to effect a policy on their own life subject to a business trust for the benefit of their co-shareholders, that is, in the same way as partners in a partnership. Which is best will depend on the facts.

In many private companies, you will no doubt find that the most important persons to cover will be the owner/ managers. They will represent the biggest group in most SME’s

Taking the individual route keeps the policy outside the company. This delivers more flexibility to the shareholding directors than under the corporate route. For example, if the whole sum assured payable were not required in the business at the time it was paid, say, because the financial loss was not as great as anticipated, then the not needed surplus could be retained as a tax-free windfall for the continuing directors.

To the extent that money from the life insurance policy was required in the company, the recipient continuing shareholding directors would typically inject the required sum into the company by way of a loan.

If the sum assured were paid into the company under a company-owned policy and the full sum assured were not required then, aside from the repayment of any loans owed to the directors, any payment from the company would have to be by way of income from employment or through dividend payments – both of which would carry income tax implications. The former would also deliver National Insurance implications.

The relative levels of corporate and personal taxation have an impact on the net of tax cost of the corporate and personal methods of effecting cover.

Using the corporate route, the policy remains an asset on the balance sheet. Whether the receipt of the proceeds will be subject to tax will depend on the circumstances but, in most cases, if the purpose of the policy is a capital purpose and not a revenue purpose, and especially given that tax relief on the premiums will generally not be available when the policy is on the life of a shareholder, the policy proceeds should not be taxable.

Using the personal route, on the death or serious illness of the life assured, the sum assured, as stated above, will be paid IHT-free under the trust to the continuing business owners who can then lend these funds to their company. This would create or enhance their loan/capital accounts with the company.

If the sum assured exceeds the nil-rate band, then thought should be given to effecting separate policies on different days, each for a sum assured not exceeding the nil-rate band and each subject to a separate business trust. Under current law, if properly executed, this arrangement should ensure that each policy trust was entitled to its own nil-rate band which should ensure that there would be no risk of IHT being payable on payment of the benefits out of the business trust.

Using the personal route may seem attractively flexible. However, the cost of providing the cover in this way after taking account of the tax aspects is usually higher. This is because, in effect, the cost of the premiums will have to be met (one way or another) out of after-tax (and, where relevant, NICs) income. A high proportion of shareholding directors are likely to have a marginal rate of tax that is higher (possibly signifi-cantly higher) than the rate of income tax paid by the company on its profits.

If you add the National Insurance cost to that, then the margin of difference can be quite high. It is worth noting that even if the company pays the premiums under personal trust policies proposed for by the shareholding directors, this will amount to “meeting a pecuniary liability” of the director and both tax and NICs will be due.

To leave the directors’ net position unaffected by the premium payments, the company would then need to pay the premiums, any employer’s NICs and sufficient additional salary such that after tax and any NICs on it the owner had enough to meet the extra tax/NICs on the premiums.
It would be possible to avoid the employer National Insurance cost if the share-holding director received the payment from the comp-any to meet the premium cost by way of dividend.

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