As a self-employed person, there is much to consider concerning the protection of your income, assets, and business. In these challenging times, many people are starting to see insurance premiums as a cost instead of an investment. Unfortunately, it is only when these insurance policies are required that we appreciate their true value.
We will now look at the types of insurance policies a self-employed person needs, the pros and cons, and the typical amount of cover.
What element of your personal and working life should you protect?
Before we look at the different types of insurance cover available, it is essential to focus on the various elements of your personal and working life which require protection.
Protecting your income, home and family
In a perfect world, we work to live, not live to work, but with the cost of living constantly rising, this can be challenging. As a self-employed person, you will have a degree of flexibility, but generally, employees have more protection. Thankfully, there are actions you can take to cover areas of your business and your personal life.
Protecting income
Whether self-employed or employed by a company, it is strange to think that income protection is well down the list for many of us. Considering that income is central to every area of our lives, maybe it should be towards the top of the list.
If your income was to reduce or end suddenly, for example, due to unemployment, how would you cover the following expenses:-
- Mortgage/Rent
- Transportation
- Utilities
- Groceries
- Housing expenses
- Debt repayments
We insure our cars, phones and possessions around the home, while many people shy away from income protection insurance. As a self-employed person, if you can’t work, you don’t get paid, which can decimate your finances. Even if you have savings to fall back upon, how long would these last?
Protecting your home and family
As the primary/significant income earner in your house, life insurance is seen by many as a critical financial support. While income protection covers short-term expenses, if you were to die, your family could be left with:-
- An outstanding mortgage
- Joint debts
- Limited financial resources
Life insurance can be structured in such a way as to cover outstanding debt on your death while also leaving a financial nest egg for your family. The level of excess capital required, over and above liabilities, will depend upon your situation, and it is vital to take professional financial advice.
Insurance options for the self-employed
This brings us to the various insurance options for self-employed people looking to protect their working income and loved ones. The following are the leading insurance policies used by self-employed people, although there are several different variations:-
Income protection
According to the Office for National Statistics, in the first three months of 2023, just over 4.2 million people were classed as self-employed in the UK (equating to around 13% of the workforce). Despite the need to protect income, a recent report by LV found that just 6% of self-employed workers had any form of income protection product. Even more alarming, 17% of self-employed workers said they would continue working despite illness or injury.
In fairness, awareness of income protection products has increased significantly since the pandemic, but there are concerns that interest could fade again over time.
What is income protection insurance?
This type of policy will pay out if you cannot work due to illness or injury. There are two types of insurance: short-term and long-term.
Short-term insurance
This style of insurance will pay a set monthly amount for a predetermined period. Successful claims will continue paying out until you return to work or the policy ends.
Long-term insurance
This type of insurance will pay out until you return to work or retire. While significantly more expensive than short-term insurance, it will depend upon your finances and your situation as to which is more suitable.
How much does income protection insurance payout?
There is a degree of flexibility regarding the level of cover provided by income protection, typically between 50% and 65% of your gross monthly income. It is important to note that income protection insurance payments are typically tax-free (assuming premiums are paid from taxed income). So, the difference between your net pay and insurance cover is less than it initially looks.
What factors influence income protection insurance premiums?
As with any insurance, the provider will take in the risks associated with your situation. There are numerous factors to consider, such as:-
- Type of job
- Age
- Existing medical conditions
- Average monthly income
- Type of policy – short-term or long-term
- Deferral period
While there are no surprises in this list, it is essential to note that those with existing medical conditions may still be able to secure income protection insurance.
The deferral period is also significant. You may have savings or a second income you can fall back on in the short term, allowing you to defer the start of insurance payments. This reduces the risk for the insurance company and, therefore, can help to lower insurance premiums for self-employed insurance cover.
Income protection insurance for employees
In theory, nothing is stopping an employee from taking out income protection insurance or, in some cases, their employer taking it out on their behalf. As an employee, you would also be eligible for statutory sick pay in addition to any income protection payments. Unfortunately, this is not a benefit enjoyed by the self-employed, who do not qualify for statutory sick pay.
Life cover
Life insurance is something we should all consider, a means of covering our financial liabilities on death and providing a degree of financial security for loved ones. As a self-employed person, life cover is in many ways, even more critical. While your loved ones may inherit your pension, there will be no one-off death-in-service benefit, something often provided by employers.
Different types of term life insurance
Term life insurance will pay out on your death over a fixed term, which can be a matter of years or for life. There are three main types of life insurance to consider which are:-
Decreasing life cover
This is especially useful for those with an outstanding mortgage, offering the ability to tie the duration of the life cover and the payout to your mortgage and financial liability. As most mortgages are capital and interest repayment, the mortgage liability will reduce (as will the policy payout) month on month before hitting zero at the end of the term. The premiums for decreasing life cover will remain constant from day one.
Level life cover
This is the most common type of life cover, a set payment if you die during a set period. As with decreasing life cover, the premiums remain constant throughout the arrangement.
Increasing life cover
This type of policy will see the payment on your death increase in line with inflation, thereby protecting your “real” spending power. You may encounter regular premium adjustments due to inflation, which can be volatile. Consequently, premiums for an increasing life cover policy will rise over time.
What level of life insurance do I require?
In theory, it matters not whether you are employed or an employee when considering the broad level of life insurance required. As a general rule of thumb, many look towards cover of 10 times the salary of the highest earner in the household. While this is not set in stone, it should provide a degree of financial security to those you are leaving behind.
Critical illness cover
Many people associate critical illness coverage with life insurance and income protection insurance. While a lot of people will add this type of cover to their life insurance policy, it differs significantly from income protection insurance.
Akin to life insurance, if you cannot work due to a critical illness and are eligible for a claim, you will receive a one-off tax-free lump sum payment. It’s important to remember that critical illness cover does not pay out on your death but will provide funds at a time which can be financially and emotionally challenging.
What impacts critical illness insurance premiums?
Before we look at various elements which will impact the insurance premiums of critical illness coverage, it is important to know that you can take out cover with existing medical conditions. These must be disclosed at the earnest opportunity and could be written into the policy as an exemption.
In general, these are the issues which will impact the level of insurance premiums:-
- Age
- Sex
- Health
- Employment
- Hobbies and lifestyle
If you’re looking for insurance coverage as a self-employed person, it is vital to take the advice of an insurance expert. There may be ways in which you can amalgamate various types of cover in exchange for reduced premiums and/or enhanced cover.
Average level of critical illness cover
Data from the Association of British Insurers (ABI) showed that in 2022, the average critical illness claim was £66,296. This is by no means some kind of target, but it does give you an idea of the average payout. To ensure that you have sufficient cover, speaking to a financial adviser is essential.
Family income benefit
At first glance, family income benefit and income protection insurance appear to be similar, if not identical. However, there are some subtle differences. Unlike income protection insurance, where you receive payments while unable to work, family income benefit will provide monthly income for your family after your death. Income protection insurance is calculated based on your gross monthly income, whereas there is no set basis for family income benefits.
Tax treatment: Premiums and payments
When looking at the tax treatment of insurance premiums and payments, they can be very different for the self-employed and employers.
Self-employed insurance cover
As a self-employed individual, whether looking at income protection, life insurance, critical illness cover or family benefit insurance, these are all types of personal cover. Consequently, as the premiums are typically paid out of taxed income, any payments received are generally tax-free.
On occasion, you may be able to make a case that the insurance is for the benefit of your wider business, including employees. While relatively uncommon, in this instance, the premiums could be deemed a business expense, while any payouts may still be tax-free.
Limited company insurance cover
Insurance premiums paid by a business are usually deemed an expense and, therefore, eligible to be offset against profits. Where the company benefits from a payout on a policy claim, this would also be subject to tax. For example, an employer may take out income protection cover to fund employee payments where they cannot work due to illness or an accident. This would go through the company books in a similar fashion to wages and attract the relevant taxation.
Where, for example, life insurance was a part of an employee’s contract, paid directly to the employee’s beneficiaries on their death, the situation is different. This could be classified as a bone fide business expense, offset against profits, while the payment would be made tax-free to the beneficiaries. You will often see this referred to as relevant life cover for limited companies.
Summary
As you can see, it tends to get a little more complicated when you look at self-employed insurance cover, premiums and payouts in more detail. In summary, if you are self-employed, it makes sense to consider income protection, critical illness, life cover and family income benefit to protect yourself and your loved ones. Most insurance cover is flexible, allowing you to sculpt different policies around your particular situation.
If you are looking to review your self-employed insurance cover, or you don’t have any at the moment, please call us, and we can look at your situation in more detail.
