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To dividend, or not to dividend – life insurance is the question

27 January 2017

Most owner managers’ companies use dividends to extract funds from their company. Even with the recent increase in dividend tax rates, the savings of National Insurance compared to salaries mean that dividends are still an effective way of saving money.

However, choosing to distribute profits in this way may have other consequences. One factor that is often overlooked is the impact on life insurance.

It is common place for companies to provide death in service insurance plans and these can provide life insurance as a 4 x multiplier of salary.  As such, if the owner takes a small salary, his life cover is significantly reduced as it does not take into account income from dividend pay-outs.

One way of getting around this issue is for the company to take out a life insurance policy known as a ‘Relevant Life Policy’. However, this type of policy is for an individual policy rather than a group policy, meaning that it could be more costly, thus reducing the savings of taking dividends rather than salary. In some cases, it makes it more costly than taking salary and the increased National Insurance costs.

A few years ago, one of my corporate clients, owned by two shareholders, wanted to enter into a cross option so that they could buy the other shareholder’s shares out if the shareholder passed away. As part of this they wanted to have life cover to use as a deposit to the surviving family whilst matters were being agreed.  One of the shareholders was 55 – he was a smoker, a drinker, and had suffered a heart attack. As a result of his circumstances, no one was willing to insure him without substantial premiums. We arranged for an IFA to obtain a quote for a death in service plan with 4 x his salary, as well as 4 x salary for his fellow owner whose salary was £100,000 and 2 x salary for each of the 40 staff.  The annual premium was £2,500 with no medicals for the shareholders, so the cost of additional National Insurance after tax relief was worth paying to obtain the cover they needed.

To find out more about the issues discussed in this blog, contact me or your local UHY tax expert. Alternatively, to read more of our tax blogs please click here.

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