When you move to contracting any life insurance benefits previously paid by your employer will be effectively cancelled leaving you and your loved ones exposed should the worst happen. To provide a financial safety net for your dependents you will need to take out a life insurance policy.
Or it might be that you already have life and critical illness cover policies that you have taken out personally, with the premiums paid with your own money after taxes have been deducted from your earnings.
You can therefore benefit greatly via the tax reliefs available by switching to a Relevant Life Insurance Plan whereby the insurance premiums are paid by your limited company BEFORE taxes are applied, thereby attracting significant tax relief.
Whether you are setting up a new policy or moving an existing one a Relevant Life Plan (RLP) provides the safety you need, exactly the same as you had when you were employed.
How is a Relevant Life Insurance Plan different?
RLPs are identical to personal life insurance except in two key respects:
- Your limited company takes out the policy, not you personally.
- You benefit from the tax relief on the premiums.
How much life insurance can an RLP provide?
You dependants can receive up to 25 times your combined income from salary and dividends as a cash lump sum if you die.
For every £100 of your daily rate, this works out as £360,000 per year, assuming a 48 hour working week.
A policy insurance of £1,000,000 can seem large but is a very common figure for contractors earning in excess of £80,000 per year. To secure a £1,000,000 life policy might cost circa £90-£100 per month if you are in good health.
Someone earning over £300 per day could secure £1,000,000. When you consider that your dependents will need the mortgage paid off and a regular income it is easy to see why you may need to insure yourself for more than £1,000,000.
Here are ten key facts about RLPs to help you choose the right protection:
1. RLPs are a death-in-service benefit payable to a contractor’s beneficiaries
RLPs are effectively the same as the death-in-service benefit that most contractors would receive when they were employed. The policy will pay out a cash lump sum to the contractor’s beneficiaries in the event of their death for as long as the premiums are paid and the policy is in force.
2. RLPs are taken out by a contractor’s company, not the contractor
Unlike personal life insurance, an RLP is taken out by the contractor’s limited company and not the contractor personally. The premiums are paid by the company and the cash lump sum benefit is paid to the contractor’s family.
RLPs are designed for companies to provide a benefit to their employees’ families. Contractors are employees of their own limited company, so the principle is the same.
3. Premiums are corporation tax deductible
Unlike personal life insurance policies, the premiums for RLPs are paid for by the contractor’s limited company out of gross fee income. As a legitimate business expense, the premiums are also tax deductible against corporation tax. So, a contractor benefits from diverting the costs to their business and the resulting tax efficiency.
4. There is no P11D benefit-in-kind to pay
There is no benefit-in-kind income tax charge for an RLP: When contractors take benefits such as a company car or private health insurance, they have to declare the benefit on their P11D at the end of the tax year. They then pay income tax and National Insurance Contributions (NICs) on the value of the benefit as determined by HMRC’s rules.
However, HMRC’s rules say that there is no benefit-in-kind charge for the premiums that a contractor’s limited company pays out on RLPs. The contractor’s employer – their limited company - foots the entire bill. There are no income tax or NIC liabilities for either the contractor or their company.
5. The benefits do not form part of an employee’s pension lifetime allowance
Another major benefit of RLP is that the policy does not count towards the contractor’s lifetime allowance for pensions. Contractors have a limit of how much they can accumulate in a pension before they have to start paying tax, which is £1.25m for the 2015/16 tax year.
Lump sum payments from a registered pension scheme would be included in this pot, and amounts in excess of the lifetime allowance are taxed at 55%. However, RLPs are not included so higher earners in particular will benefit.
6. The lump sum can be worth up to 15x salary and dividends
When employed, many contractors will recall that their death-in-service benefit would have paid out a multiple of their salary, typically between three and five times. RLPs recognise that contractors take their remuneration tax efficiently through a combination of a low salary and dividends.
Contractors can choose to take out a policy that pays out the multiple of salary and dividends that they choose, or can best afford. Although there is no statutory maximum, the maximum multiple offered by most providers is typically 15x salary and dividends, which for high earning contractors can be a considerable sum to leave to their loved ones.
7. The payout is free from income tax and inheritance tax
As well as being tax efficient to pay for, an RLP is also tax efficient when paying out. There are no income tax or inheritance tax liabilities for the contractor or their dependents should the contractor suffer an untimely death and the policy pays out.
8. RLPs only include death benefits and only pay out a lump sum
As well as understanding the benefits, it is important for contractors to understand what RLPs won’t cover. An RLP will only pay out a lump sum to a contractor’s dependents in the event of their death. An RLP is not a critical illness or income protection policy.
Contractors should make separate provision for income protection in the event that they become too ill to work. Their RLP is not a substitute for this kind of protection.
9. There is no surrender value
Unlike some pensions and investments that pay out if they are cancelled early, an RLP is a life insurance policy. It remains in force as long as the contractor’s limited company maintains the premiums and none of the conditions of the cover are breached. If the contractor chooses to stop paying the premiums, then the cover simply stops and there is no surrender value.
10. Policies must not be set up for tax avoidance purposes
RLPs use discretionary trusts that are taken out and paid for by the employer – the contractor’s limited company – to pay the beneficiaries: This type of financial structure is open to abuse and under some circumstances can be used as a tax avoidance vehicle.
For that reason, financial services providers stipulate that the contractor can only specify individuals, such as family members, and charities as beneficiaries. The employer, the contractor’s limited company, cannot be a beneficiary to avoid any suggestion that the policy has been created for tax avoidance purposes.
Contractors should seek professional advice from a financial adviser before taking key decisions about RLPs and other forms of protection.