Tony Granger examines possible savings that can be made from having combined insurance policies for businesses and shareholders.
The scenario envisaged in this takes into account ‘Keyperson’ insurance for a company or limited liability partnership where premiums are payable by the business, and then shareholder protection where the shareholders take out life assurance on each other’s lives to provide cash for the sale of their shares on death (or certain disabilities).
The traditional route is for the company to take out a life assurance policy on the key person to protect the company in the event of death, including its liabilities and the costs of replacing that key person. Separately, the shareholders take out policies on each other (or on their own lives and assign the policy to the other shareholders in trust).
Let’s assume that there are three shareholders who are also key people. That would mean six different insurance policies, with policy costs and management. It also means that some policies are taxable (Keyperson) and others not (shareholders).
Keyperson Polices owned by the company
(a) Term policies for a term of five years or less and owned by the company would generally have the premiums deductible for the company. The policy proceeds on death would be taxable in the hands of the company (i.e. being added to company income). Premiums and cover must be reasonable, and it is wise to obtain HMRC approval for the deductibility of premiums.
Example: Death of key person
A five-year term policy for £500,000 cover has £100 per month premiums.
The key person dies after three years and the company receives £500,000 which is taxed at 19% (i.e. £95,000 corporation tax payable).
Premiums amounting to £3,600 would have been deductible in total over the three years.
(b) Whole of life keyperson policies owned by the company do not have the premiums deductible, and the gain on the policy is taxable (not the policy proceeds). After three years, the amount of investment gain within the policy would be negligible. For example, if the gain is £2,500, the corporation tax payable at 19% is £475.
In both cases above, the keyperson policy proceeds are ‘trapped’ in the company. The shareholders may require more flexibility.
Shareholder protection policies
Shareholder policies can be term or whole of life policies. The premiums are not tax deductible and the policy proceeds are tax-free on death. If the company pays the premiums, these are added to the income of the individuals for tax purposes. On the death of the shareholder, the policy proceeds are payable to the surviving shareholders (usually in trust) who purchase the shares of the deceased for cash.
For example, assume each policyholder takes out cover of £250,000 and pays the premiums. The shareholders would have a double option agreement in terms of the arrangement. The deceased’s personal representatives have the option to call for the proceeds and the surviving shareholders have the option to buy the shares. This arrangement is potentially efficient for inheritance tax purposes, as it should be effective in preserving any business property relief otherwise available in respect of the deceased’s shares. Double option agreements are contracts for pre-sale and IHT effective, whereas Buy and Sell Agreements are post-sale and IHT BPR reliefs are lost.
Combination agreements
Using a combination agreement potentially results in a tax saving on the Keyperson portion and increased flexibility for the surviving shareholders to fund the company.
For example, the Keyperson policy cover of £500,000 is combined with the shareholder protection policy cover of £250,000 for total cover of £750,000 taken out by each shareholder. Premiums are not deductible, and the policy proceeds are tax-free. Clauses in the agreement cover the double option share sale purchase on death at £250,000. The balance is for the benefit of the shareholder, who now has the choice to fund the company in terms of amount and frequency. Any money advanced to the company is now by way of a director’s loan account and is not taxable in the company. Policy costs are reduced as there are now three policies instead of six, as previously. Agreement clauses can cater for critical illness and other covers.
Practical Tip:
Consider Keyperson and shareholder life cover to protect the business and shareholders. Use a combination agreement for tax savings and flexibility.
