Contractors seeking to soften the blow of the dividend tax changes can cut their tax liability by transferring their personal life cover into a policy paid for by their limited company. At the same time contractors can also make corporation tax savings.
“Many contractors enter contracting with legacy life assurances they took out when employed and have been paying for personally,” highlights Andy McBride, life and income protection expert at CMME.
“Now that the dividend tax changes have taken effect, contractors should look at all their costs and see what can legitimately be moved into their business. Life insurance is a good example of this type of cost. Furthermore, contractors should regularly review their protection insurances to ensure their cover has kept pace with changing lifestyles.”
Does company life insurance save corporation tax?
As McBride explains, contractors who decide to move their life insurance from a personal to a company policy, or Relevant Life Policy (RLP), make savings on two fronts: dividend tax and corporation tax.
“Although every policy is different and depends on a wide range of factors, the median contractor spend on a life insurance policy is £50-£100 each month, which totals £600 to £1200 each year – enough of a sum to worry about.
“If a contractor is paying that personally, they have to pay corporation tax and then dividend tax before the money is theirs, so pound for pound it is a very expensive process. The alternative is to set up an RLP.
“RLPs can provide the same level of cover but the cost is paid for by the company. This means there is a corporation tax deduction, as life insurance costs are a legitimate business expense that reduce a contractor limited company’s profits. The overall savings for the contractor can be as much as 20-25%.”
How to change personal life cover to an RLP
McBride confirms that switching cover is a straightforward process: “The first step is for a contractor to speak to a financial adviser. If they still have a legacy personal life policy, the chances are that the policy is quite old and the level of cover may no longer be suitable for their current situation.”
Contractors typically earn much more than when they were employed and in McBride’s experience, this can result in a significant lifestyle change. As most contractors take out life insurance to ensure their family is financially secure in the event of an untimely death, the insured sum and payout must reflect the family’s lifestyle expectations.
“As the RLP is a completely new policy with fresh underwriting, we can review the contractor’s requirements and adjust the policy and premiums accordingly. Contractors frequently upgrade their cover at this stage.”
And McBride notes that in a very few cases the personal policy remains the best option, perhaps supplemented by a new RLP policy: “An older personal life insurance policy may be very keenly priced yet still have a generous payout, so the outcome of the review is not always to discard the existing policy.”
Can contractors keep their RLP if they return to employment?
One of the best features of a typical RLP is its flexibility, as McBride explains: “If the contractor returns to permanent employment they can convert their company-funded RLP into a personal policy.
“They can retain the same level of cover with no additional underwriting required but pay for it personally. If the contractor’s new employer provides life insurance to its staff, the contractor could ask their new employer to take on and fund the policy. Or, if the new employer already has a group scheme, the contractor can simply cancel their RLP.”
McBride concludes: “Reviewing existing life insurance arrangements can potentially lead to several benefits, not least of which are the tax savings. So, now that the dividend tax is in force, the sooner contractors get their current arrangements review, the sooner they can start benefiting.”