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Put new life into business

If you were asked to name a profitable area of financial planning, the chances are that basic life insurance would not immediately spring to mind. But one area of protection planning which IFAs largely miss out on at the expense of banks does fit the bill – business loan protection.

Business lending is almost always conditional upon key people within the business being protected by life insurance and, increasingly, critical-illness cover. Banks tend to enforce this condition where repayment of the advance is heavily dependent upon the future performance of one or more individuals within the business. Good examples are management buyouts and young businesses that are growing strongly.

It is not unusual for banks to ask for life insurance of £1m on particular individuals and even higher in some cases.

The majority of this protection business tends to be picked up by the banks themselves but does the customer get the best deal? Probably not, as most of the high-street banks are tied to offering rates from one provider. This means IFAs are ideally placed to compete for this business either by writing cover for new loans or rebroking existing cover.

How do you get into this market? First, make sure you extend financial planning for your business customers beyond pension planning.

Target local businesses by offering to review their life insurance – you could save them tens or even hundreds of pounds a month, even if their policy was taken out a few years ago.

Use contact with businesses stimulated by stakeholder as an opportunity to build your business customer base.

There are many other ways to market your services successfully to businesses and the effort should prove worthwhile as these customers tend to present opportunities for repeat advice more frequently than individuals.

Once you have the attention of the directors or partners there are a few points to consider when giving advice.

What type of loan? There are two basic types of business loan.

Term loans – these are virtually always written on a capital and interest repayment basis (similar to personal mortgages) over terms ranging from three to 15 years. One curious feature to watch out for are moratoriums. This is where the bank allows the business a period, usually the first one or two years of the loan, during which no capital is repaid – only interest is payable – or even where nothing is repaid. This has the effect that the outstanding loan amount either stays the same or increases during this period.

Overdrafts – these are usually one-year renewable loans providing working capital for the business. Despite their apparent short-term nature, these loans tend to continue almost indefinitely.

What type of life insurance policy? For most term loans,a mortgage protection policy suitable for business use will be the most appropriate, although there are cases, such as loans with moratoriums, where level term insurance will be better suited.

Overdrafts are a bit harder to categorise. Should the cover be at the overdraft limit or for a lower amount representing the normal amount overdrawn? The almost open-ended nature of overdrafts also presents difficulty when deciding on the term of the policy. Depending on individual circumstances, level term, renewable term or flexible whole-life insurance could be most suitable.

Who to insure? The directors or partners are obvious candidates, as are senior managers or employees with special skills. The loan agreement will usually specify who is to be covered and for how much.

Insurable interest needs to be considered and banks sometimes fail to understand they cannot insure their chosen subject for the full amount of the loan. This is particularly the case for limited companies, where the company can only insure its employees (including directors) up to the amount of any potential financial loss that may arise from their death or critical illness.

Who should be the policyholder? For limited companies, the policyholder (policy owner) is normally the company, as the amount available from any claim would be required by them to repay in full or in part the outstanding loan.

For partnerships and sole-traders, each individual should set up their own life policy relative to their share of the loan.

What is the tax position for limited companies? The answer depends upon the type of policy. Term insurance premiums will not qualify as a deduction from profits. The tax position of any proceeds payable from term insurance owned by a limited company is generally governed by the principle that, if tax relief is not allowed on the premiums, then the proceeds will avoid tax. But individual cases have received different treatment. Best practise would be to seek clarification from the company&#39s insp- ector of taxes at the outset of the policy.

The position for whole life is more straightforward with the premiums not allowable as a business expense.

If the proceeds become payable, this triggers a chargeable event and there could be a tax liability to the extent that the surrender value exceeds the premiums paid. In the case of flexible whole life written on a maximum sum assured basis, the surrender value is likely to be lower than the premiums during the initial 10-year period until the first review of the premium/sum assured. This means any claim arising within the first 10 years (and perhaps longer) is unlikely to give rise to a tax charge.

What is the tax position for sole traders and partners? As the policies are on their own life, no tax relief is available on premiums and proceeds are tax-free. This applies to qualifying whole life and term insurance.

Are there any other options I should consider when advising on business loans?

One area that may be ignored by banks is the tax advantage available from structuring borrowing through a Sipp or small self-administered scheme.

To do this successfully, you need to know in advance that your business customer is considering the purchase of new commercial property.

Often, the businessperson only finds out at the last minute that this is an option, by which time the property has already been bought by the business.

This is a good example of where forward planning can add significant value to the customer relationship.

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