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Sole Trader Insurance – Key Man Life Insurance

There are 3.3 million sole traders operating in the UK with around 1 in 7 of the workforce is self-employed. Unfortunately, it’s still the case that too few businesses cover the life of the owner. Sole trader life insurance is extremely valuable and can protect the business, the owner’s family and potentially any employees that work for them. Without life insurance in place, it can massively impact the family finances. Not to mention if the sole trader were to fall ill and be unable to work.

Main benefits of sole trader life insurance

As a sole trader, you yourself are one of the most important assets to the business. When a sole trader dies a number of financial and contractual obligations will still need to be fulfilled. Let alone, the closure of the business and letting any employees go. This often falls to the spouse or next of kin if there is no succession plan in place.

Accounts need to be closed down, loan repayments need to be met or paid off. If the sole trader had any members of staff, they will need to be told to look for other work and any redundancy pay will need to be sorted. In addition to fulfilling contractual obligations such as providing goods and services to clients that have already purchased them.  Even if the business were to stay open and a beneficiary was to take over the role, changing the business name, accounts and insurance policies could take up a lot of time and money.

The main benefit of sole trader life insurance is to provide financial support in order to facilitate these activities. It ensures that the family or beneficiaries are not burdened with the financial responsibility and suffer as a result. It also means that you can leave a little behind for your family, as well as supporting any employees when they are suddenly out of a job. Sole trader insurance isn’t a legal requirement. However, if you employ people it may be worth getting protection. In addition to protecting your loved ones.

Are sole traders eligible for relevant life cover?

One of the main attractions of a relevant life policy is that it is a tax-efficient life insurance policy. This is why it’s such a popular policy for directors and owners looking for life insurance. However, relevant life is not suitable for sole traders. In order to offset the expenses against tax, it needs to be seen as a business expense, rather than for personal gain. When an individual owns the business but takes out life insurance on themselves, it is seen as for personal purposes, rather than for the business.  It is hard to determine a line when the sole trader is usually the business itself. The policy then no longer becomes relevant life and instead becomes a personal policy and cannot benefit from tax relief.

So, what are the options?

1) A personal life insurance policy

The obvious answer may be to just take out a personal policy. The premiums are then paid for out of your own pocket; from your net salary. You’re also not able to claim it as a business expense which means no tax benefits. The main benefit of a personal life insurance policy is that the payout goes directly to your family to support them in the event of your death. Your family can then use the money to carry on their way of living and liquidate the business.

2) Key man insurance cover for sole traders

If you’re looking for sole trader life insurance that is tax-efficient, you can look into key man insurance instead. A key man policy is owned by the sole proprietor still, but the payout isn’t taxed in the event of a claim. This means more money can go back to the family to sort out any affairs. This can cover cash flow, paying any staff, recovering lost revenue and loans.

What are the tax benefits with key man insurance for sole traders?

If you have sufficient evidence that your key man policy is for the purposes of the business, then the premiums may be eligible for tax relief. In some cases, you can offset the monthly premium payment against any corporation tax. With key man insurance, the payout is normally taxed instead. Therefore, it can be beneficial to take out a higher amount of cover to ensure that your beneficiaries get the amount you originally intended.

This is always difficult to prove in the case of a sole trader as there is no distinction between the sole trader as an individual and the sole trader as a business. Therefore, a fully tax-efficient policy cannot be obtained. However, with a key man insurance policy for sole traders, whilst they cannot claim the premiums as a business expense, the payouts are not taxed. Sole trader life insurance is written into a trust with the family as beneficiaries. They then receive the full payout, exempt from inheritance tax. This money can then help them closing down the business as well as providing them with financial security.

Check your status with HMRC

Unfortunately, the tax rules on a key man can be fairly complicated. Therefore, it’s worth knowing the guidelines and getting advice from the tax inspector, your accountant, a financial advisor or your local tax office. Often, decisions made purely for tax reasons aren’t usually the right ones. With sole traders, it is frequently the case that no distinction is made between the business and the sole trader, and then cover is determined as personal protection. The good news is, if the payments are not eligible for relief then the financial payout is likely to be treated as a capital receipt and therefore, unlikely to be taxed.

How is it set up?

A key man insurance policy is fairly easy to set up. A key man policy is normally written into a trust from the outset. The insured person can choose the beneficiaries they’d like the money to go towards. Medical guidelines for underwriting are typically the same as writing a personal policy. It is normally taken out on a term policy with a minimum of 5 years. There are also options to increase or decrease cover over time to meet your specific needs.

How much cover is required?

With sole trader life insurance, the level of cover is normally based on the financial impact of losing the individual. Often, this can mean closing down the business and enough cover should be taken out to facilitate this. A financial payout can ease the process as well as support the family during this time. Whether the benefits will be taxed can also affect the cover amount. If your premiums are eligible for tax relief, then often the payment will be similarly taxed. Therefore, a higher amount of cover might be required in order to counteract the payment.

Is critical illness included?

With key man insurance, you are normally covered for terminal illnesses. This is a serious illness with 12 months or less to live. Critical illnesses are something different. With key man insurance, you can have the option of adding critical illness cover to your policy. This will pay out a lump sum if you are diagnosed with a serious illness such as cancer, heart attack or stroke. This is designed to pay any health care bills or cover the business whilst you are unable to work.

Manual workers and life insurance

Manual workers are a higher risk factor when it comes to life insurance. Therefore, it is likely that your premiums are going to be a lot higher. There are ways to reduce the premiums such as taking out decreasing cover or extending the deferred period. You can also just choose to cover the essential expenses to reduce the overall monthly cost. However, it is important to have the right amount of coverage that will help and support your family.

If you’d like a quote or to discuss your sole trader life insurance options, get in touch. At Business Cover Expert we provide free, qualified advice to find the right policy for you.

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