Life insurance arranged by employers can provide vital financial protection for employees, their families, and the business itself, with important tax rules to consider.
Employers often take out life insurance cover to protect against the financial impact of losing an employee. This may be through:
- Death in service cover – paying proceeds to the employee’s family or nominated beneficiary.
- Key person insurance – paying proceeds to the employer to offset the business impact of losing a key employee.
In owner-managed businesses, policies may also be arranged for directors or their families personally, funded by the company.
Death in Service Payments
- How it works: Commonly set up as a relevant life policy, with annual premiums paid by the employer.
- Tax treatment of premiums: Normally deductible for the employer and not a benefit in kind for the employee, making this a tax-efficient element of remuneration.
- Inheritance Tax (IHT):
- Concerns were raised around April 2027 changes, when pension funds will be brought into death estates for IHT.
- It was feared that lump sum payments from death in service schemes could also be caught.
- HMRC has now confirmed these lump sums will remain outside the new IHT rules, which is very welcome clarity.
- Why it matters: This reassurance maintains death in service policies as a highly attractive, tax-efficient employee benefit.
Key Person Insurance
- Purpose: Protects the business where the loss of a director or key employee would cause financial disruption. Cover may be designed to:
- Settle liabilities such as outstanding loans.
- Replace lost trading income or provide funds for recruitment/restructuring.
- Premium deductibility:
- If the policy is aimed at making good trading income losses, premiums may be deductible against trading profits (subject to conditions).
- If the policy is linked to a capital item such as repaying a loan, premiums are not deductible.
- Treatment of claim proceeds:
- Where premiums qualified for tax relief, claim proceeds will usually be taxable. Deductible costs such as replacement staff salaries may offset this.
- Where premiums were not deductible, the proceeds are normally not taxable.
- Important point: The tax treatment of proceeds depends on whether the premiums met conditions for relief — not simply whether relief was claimed in practice.
- For employees: As the policy benefits the employer, there are no employment tax consequences for the insured individual.
Policies for Directors’ Personal Benefit
- If a company funds a director’s personal life insurance, the premiums are a taxable benefit in kind.
- From April 2027, these will need to be reported via payroll (currently via P11D) and will attract Class 1 NIC.
- Always check who the policyholder is when arranging new cover to ensure the correct tax treatment is applied.
Taking Professional Advice
While tax rules are important, life insurance should be considered within the wider context of financial planning. An independent financial adviser can ensure the right policy is chosen and structured appropriately.
