Trusts, tax and business
Key person insurance: how much cover, and how HMRC treats it
A business can insure the life of someone whose loss would cut its profits. Enter the profit they bring in and the time it would take to replace them.
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Key person cover from lost profit
Example, not your result yet· change a figure to see yours
Cover a business might set
£175,000
| Lost profit over the period | £150,000 |
| Recruitment and training | £25,000 |
| Contracts or loans | £0 |
HMRC allows the premiums against profits only for term cover taken out to replace lost trading income (BIM45525); the payout is then taxed as trading income.
Key person insurance is a policy a business takes out on the life of a director, employee or other person whose death or long absence would cut its profits. The business owns the policy, pays the premiums and receives the payout. One common way to size it is the profit the person brings in over the time it would take to replace them, plus the cost of finding and training a successor, plus any loans or contracts that depend on them. On £150,000 a year of gross profit, 12 months to replace the person and £25,000 of recruitment costs, that gives £175,000. HMRC’s Business Income Manual, at BIM45525, says the premiums are allowable against profits only if the sole purpose is to meet a loss of trading income from losing the person’s services, not a capital loss, and if a life policy is term insurance with no other benefits. Where the premiums are allowed, the payout is taxed as income of the trade.
Rates read and sums checked by Radif Partners · Editorial policy · How the figures are worked out
Cover by time to replace the person
The table keeps £150,000 a year of gross profit and £25,000 of recruitment and training, and changes only the months it would take to bring profit back to its level. A business that depends on one person’s clients or skills may need longer; one with a deputy ready may need less.
| Time to replace | Lost profit | Recruitment and training | Cover |
|---|---|---|---|
| 6 months | £75,000 | £25,000 | £100,000 |
| 12 months | £150,000 | £25,000 | £175,000 |
| 18 months | £225,000 | £25,000 | £250,000 |
| 24 months | £300,000 | £25,000 | £325,000 |
The HMRC conditions in plain terms
BIM45525 sets two conditions for the premiums to be allowable. First, the sole purpose of the insurance is to meet a loss of trading income that may result from losing the key person’s services, not a capital loss; HMRC gives guidance on non-trade purposes in the next section of the manual. Second, a life policy is term insurance, covering only the risk of death within the term with no other benefits, and the term should not extend beyond the period of the person’s usefulness to the company. Premiums on whole of life or endowment policies, or on critical illness or accident policies with an investment content, are capital expenditure and not deductible. Endowment policies taken out as a condition of a long-term loan are not deductible either.
When both conditions are met, the premiums are deducted and the payout is taxed as income of the trade. The two go together: a business cannot deduct the premiums and receive the payout free of tax.
How often a short term pays
Key person policies tend to run for short terms, in line with the condition on the person’s usefulness. The chance of a death claim within five years, on the ONS life tables, is small at working ages, which is part of why the cover is affordable relative to the sum.
| Age of the key person | Death within 5 years, man | Death within 5 years, woman |
|---|---|---|
| 35 | 0.65% | 0.37% |
| 45 | 1.4% | 0.87% |
| 55 | 3.1% | 2.0% |
Personal cover is separate
A key person policy protects the business, not the person’s family. The family’s own need is sized on the life cover calculator; a director with no employer sick pay can look at the self-employed income protection page for the income side.
The figures in the calculator are the business’s own estimates. Writing down how each was reached, and keeping that note with the policy, keeps the reasoning clear for the insurer, for the accountant and for HMRC.