Contractors can apply for income protection policies that provide a level of cover based on their annualised contract rates, and not just on their salary. This is according to Tony Harris of independent financial adviser (IFA) ContractorFinancials, which has negotiated special contract rate-based policies and mortgages for UK contractors.
“Income protection policies traditionally provided a monthly income based on a percentage of an employee’s gross salary if they are unable to work through illness or injury,” explains Harris. “This approach has always worked against limited company contractors, who tend to take lower salaries for tax-planning purposes that are then bumped up by dividends. This has left many thousands of contractors underinsured and potentially paying for protection that may not pay out in the event of a claim.”
Harris continues: “Whilst certain schemes will protect dividend income, this is far from ideal due to the impact of retained profits. However, if the income protection is based on contract rate then the contractor can claim a far higher income if they are unable to work due to illness or injury. And such a gross contract approach is unaffected by the salary or dividend that contractors choose to draw from their limited companies.”
Contract rates versus salary
According to Harris, income protection policies based on annualised contract rates can be of huge benefit to contractors: “Calculating, and proving, an employee’s salary and using it to calculate the income from the policy and its premiums is straightforward.
“However, limited company contractors not only have low salaries relative to their total earnings, but their income may also fluctuate on a monthly basis during the course of a year as they change contracts. Basing income and premiums on an annualised contract rate can allow for this.”
For example, a contractor earning £30 per hour working 35 hours per week for 52 weeks of the year could earn a gross annualised contract income of £54,600. Based on this ideal annualised sum, a contractor taking out a basic income protection policy could expect to receive £2,275 per month, which is 50% of their annualised contract income, if they are unable to work.
And contractors can opt for higher cover, depending on their personal circumstances, as Harris explains: “There are income protection policies that will provide incomes of up to £12,500, although of course monthly premiums will increase to reflect the higher cover.”
Contractor income protection – how much will it cost?
“Costs can vary depending on the level of cover required, but a typical 36-year-old non-smoking male IT contractor with no medical conditions can cover themselves to age 60 for just £49 per month,” Harris says. “For this monthly premium the contractor would receive an income of £2000 per month if they are unable to work due to illness or injury, and the policy would begin to pay after a three-month deferment.” [Figures correct at time of writing].
However, Harris stresses that every contractor and their personal circumstances are different, and so individuals should consult an independent financial adviser before making any decisions, particularly as a contractor’s circumstances can change over time.
Premiums can vary considerably according to occupation, age, pre-existing medical conditions, family medical history, the policy’s length and other factors such as lifestyle. Another important factor is the deferment period – the time a contractor is not working before the policy is activated and they start taking an income from it.
If a contractor can't work because of an accident or illness, then they won't get paid
Tony Harris, ContractorFinancials
Depending on a contractor’s personal circumstances, policies are generally best taken out personally, rather than through the contractor’s limited company, to avoid the benefit being subject to income tax under Pay As You Earn (PAYE) when it is claimed. The income paid out by the policy itself is tax-free if the premiums have been paid personally.
Why contractors should consider income protection
“Most employers have policies that provide their employees with long term sick pay to run alongside their statutory sick pay,” says Harris. “As a result, many permanent staff can expect to receive their full pay for extended periods that can be a long as twelve months or more, depending on the employer.”
But, Harris warns, contractors simply don’t have this perk of being employed: “If a contractor can’t work because of an accident or illness, then they won’t get paid. And if they don’t have savings, the contractor and their family could rapidly run into financial trouble, possibly losing their home as state benefits just won’t cover the costs.
“Sadly some freelancers and contractors take out unsuitable accident, sickness and unemployment cover, which can lead to a false sense of security. These policies will often only pay out for a very limited time, and in many cases are inappropriate for those on short-term contracts, which could leave contractors dangerously exposed.”
According to Harris, an income protection policy can maintain a minimum level of income to cover mortgage costs and bills until the contractor recovers, or could provide a vital source of income until retirement if the condition is long term.
Tony Harris is MD of ContractorFinancials, recognised as the specialist independent financial adviser for Contractors.
ContractorFinancials offer jargon free and timely mortgage, pension, insurance and investment solutions tailored to the unique needs of Contractors.
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He points out that more than half of the 2.62 million people in the UK on incapacity benefit have been off work for more than five years. “And in the short-term, nearly 25% of all people aged 35 will at some point during their working life suffer a disability lasting more than three months. So,” Harris concludes, “an income protection policy should really be viewed by contractors as a ‘must have’, not a ‘nice to have’.”
Published: Thursday, May 05, 2011
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