Income protection for contractors, often called Executive Income Protection, is a type of sickness insurance that pays out a monthly benefit if you become too ill or injured to work. Similarly to traditional income protection insurance, it's designed to protect your outgoings, such as your mortgage, rent, utilities and groceries, when you're unable to work.
This type of self-employed income protection is excellent for limited company directors, freelancers, and contractors, as you can pay for the premiums through your business tax-free. Executive Income Protection policy premiums are usually tax-deductible. The policy is also not considered a P11D benefit in kind, making it a tax-efficient way to get income protection insurance.
- You can cover up to 80% of your monthly income, including your salary, dividend drawdown, pension and National Insurance contributions.
- You're able to cover your partner's dividend drawdown, too, as long as they are non-profit making and wouldn't be able to create income for the business while you were unable to work.
- You can opt for a policy which will pay out after four weeks of injury or illness (deferred period).
- You can protect your income up until your expected retirement age.
- HMRC usually sees it as an allowable business expense, meaning premium payments come from your corporation tax bill.
- It's not a P11d benefit in kind and, therefore, a tax-free benefit for self-employed contractors.
A Contractor Income Protection Insurance policy covers up to 80% of your normal income if you cannot work due to illness or injury. With this type of self-employed insurance, you can protect your salary and dividend payments, alongside National Insurance and pension contributions. You can also cover your partner's dividend drawdown, just as long as they're in a non-profit generating role within the business.
1. Setting up a policy
When it comes to setting up a contractor protection policy, a lot of thought and consideration should be given to ensure you have the right level of cover. It's why it always pays to speak to a specialist, like our partners at Sandbourne, as they'll be able to guide you through everything from configuring your income protection policy to choosing the best insurer for your circumstances.
2. Making a claim
If you're unable to work and need to make a claim, you can do so via your insurer's dedicated claims team. Your policy documentation will include their contact details and information about their specific claims process.
When you make a claim, your insurer will ask you to complete a claims form and provide evidence of your medical condition - a note from your GP will usually suffice. Unlike other types of insurance, like critical illness cover, where you are restricted to a set list of medical conditions you can claim for, with income protection, almost any medical condition will be covered, so there is often a high probability of a successful claim.
3. Receiving a payout
As soon as your claim has been approved by your insurer and assuming your deferral period has passed, you'll start to receive a monthly payment instead of your wages. You'll continue to receive this income until one of the following happens:
- Your payment period expires
- You're well enough to return to work
- You reach retirement age
Contractor Income Protection Insurance is designed to pay out if you're unable to work due to illness or injury, and there are typically very few limitations to that. While there tend to be very few exclusions on a policy, insurers will offer differing "definitions of incapacity". Therefore, it's essential to understand what this means and how it can affect your cover.
Before we look at the various definitions of incapacity you'll encounter, let's first detail some of the few standard exclusions that insurers have in place that may limit claims:
- Drug or alcohol misuse
- Self-inflicted injuries
- Travel to a country with political instability, internal conflict or an active epidemic.
The only other significant factor to consider is pre-existing medical conditions, which we'll cover next.
When you apply for a new policy, any medical conditions you've experienced or had treatment for in the past five years will need to be declared. Each insurer will have its own view or policy on pre-existing medical conditions, but primarily you can expect them to do one of three things:
- Cover the pre-existing medical condition on standard terms
- Offer to cover the condition for an increased premium
- Exclude the medical condition from the policy
As we alluded to earlier in this section, insurers use three definitions of incapacity, which determine how unwell you need to be to make a claim. Therefore, understanding this critical part of the policy wording is vital. The three definitions you'll encounter are (ranked best to worst):
- Own Occupation
- Suited Occupation
- Any Occupation / Work Tasks
Own Occupation
An "own occupation" definition of incapacity means that your policy will payout if you're too unwell or injured to work in your current occupation. It is, without doubt, the most comprehensive and the easiest to claim under and therefore the one we tend to recommend to our customers. You set your desired deferred period if you can't perform your duties.
The vast majority of clerical (office) workers will be able to get "Own Occupation" cover, regardless of the insurer, but for risky occupations and those which are very manual, it can be difficult. Some companies offer this type of definition of incapacity cover for all but the riskiest occupations, but their number is limited; your income protection insurance will pay you a monthly income.
Suited Occupation
Contractor Income Protection policy that uses the "Suited Occupation" definition of incapacity will typically provide less cover than one with the "Own Occupation" definition. With this definition, the insurer may expect you to return to work in an occupation for which you have the skills, training, qualifications, and experience.
For example, you might be a skilled and experienced self-employed contractor working as an IT Director for a fast-growing firm, but you cannot continue in that role due to stress. With a suited occupation definition of incapacity, the insurer may insist that you take a less stressful role at the same company or elsewhere.
As you can see, in this example, the difference in definition has a significant impact on the insurer's restrictions and the terms of your income protection insurance policy.
Any Occupation / Work Tasks
Finally, the least favourable definition you might come across when looking at self-employed contractor income protection is "Any occupation or work task", which is by far the most restrictive, providing very little protection against all but the most severe illnesses and injuries.
Under this definition of incapacity, the insurer will only pay out if the policyholder cannot complete some rudimentary tasks. These include things like walking, bending, seeing, hearing and climbing. Usually, the policy will pay out if the individual can't do three or more of these tasks. As you can see, this definition is so restrictive that it undermines many of the benefits of income protection insurance and is therefore not usually recommended.
With so many aspects of each self-employed contractor's policy and individual circumstances varying, it's challenging to provide you with exact pricing for contactor income protection. Still, we can give you some rough figures based on some pre-selected criteria.
To provide you with a cost of contractor income protection, we've assumed:
- The individual wants a benefit of £2,500 a month
- They are not in ill health and are an office-based contractor/company director
- They would like a 3-month deferred period
- The plan expiry will be 68 (probably state pension age)
- Maximum claim length, cover continues until they turn 68 or can return to work
- Index-linked - tracking Retail Prices Index
- The premium is guaranteed for the life of the policy
- The individual is a non-smoker
Example cost of self-employed contractors' income protection (May 2022)
Based on the above criteria, these are the best-priced policies based on several different ages:
- 20-year-old - £22.92 per month
- 30-year-old - £34.57 per month
- 40-year-old - £54.41 per month
- 50-year-old - £78.19 per month
What affects the cost of contractor income protection policies?
This section details the options you'll have when setting up your self-employed contractors' income protection policy, alongside factors outside of your control that will affect the cost.
Income protection cover level
Firstly, the level of cover you need will play a significant role in the ultimate cost of your contractor income protection policy. For example, if you're a high earner and have substantial commitments, you can expect the cost of your income protection policy to be relative. As with any insurance, it always pays to speak to a business protection broker and compare providers to ensure you're getting the best terms and prices. The service that brokers provide is free, and they are also entirely independent, meaning you get help choosing the right income protection cover for you without spending a penny.
When you set up your income protection policy, there will be several types of premium you can choose from, each with its pros and cons and associated cost implications.
Your first choice is whether your premium will be reviewable or guaranteed:
- Reviewable premiums - this premium type allows the insurer to review the premium at regular intervals, usually every five years. While income protection written with this choice is often cheaper from the outset, you have no control over what increases the cost of the policy the insurer may make in future.
- Guaranteed premiums are the alternative to a reviewable premium and mean that you know your price in the future (not that it is fixed - this is often confused with a fixed premium).
Your second choice relating to your premium is whether it will be age-banded or fixed:
- Age-banded premiums - policies with this premium type will increase over time as you get older. Unlike Reviewable premiums, where you have no foresight or control over those increases, you will be told in your policy documentation exactly how much your policy will increase each year, allowing you to be better prepared for the additional cost.
- Fixed premiums - these will not change over time due to age. However, they may still change if your premium is reviewable or index-linked.
Your final choice is whether or not you wish to index link your policy:
- Index Linking - if you decide to index link your plan to track with inflation, your price will increase over time as your benefit amount rises as it tracks with inflation. Typically policies will track the Retail Prices Index (RPI).
For most people, the best option is typically a "guaranteed", "fixed premium" with "index linking" for inflation tracking. Although the most expensive initially, over the entire plan duration, this will usually work out cheaper in the long term than a reviewable or age-rated plan.
The length of your policy payout period will impact the cost, so careful thought should be given to whether you need cover in the short-term or if you want something to cover you for much longer. Short-term policies typically pay out for between 1-5 years per claim, whereas longer-term policies can protect you until retirement.
Your policy cease age
The policy cease age is how old you'll be when the policy ends, with most people setting this to be the date where they will no longer be working, i.e. their retirement date. Some providers will let you have cover that lasts up to age 70, but these policies tend to attract far higher premiums than those ending at 65 or 60 years of age.
Your Age
The first of the factors you don't have any control over, your age, will affect the cost of your policy. The older you are, the more likely you are to become unwell and therefore, premiums will be higher for those individuals starting policies later in life.
Any health conditions you may have
As we previously mentioned, any health issues you've suffered from in the past five years need to be declared and depending on how the providers treat them; your premiums could be higher. That isn't always the case; the insurer sometimes will instead exclude that condition rather than loading the policy in most circumstances.
Your smoker status
As we all know by now, smoking puts us at a much higher risk of various serious health issues, and therefore, if you are a smoker, you can expect insurers to increase your premiums accordingly.
Your occupation
Your occupation will play a significant role in the pricing of your policy. While office workers will generally enjoy lower premiums, those working in manual trades or high-risk occupations can expect to pay more.
Definition of incapacity
Finally, as we've already outlined, the definition of incapacity used on your policy will also be crucial in its price.
As you can see, Contractor Income Protection is far from straightforward, with many options and potential pitfalls. All contractors are different, and we strongly recommend that you speak to an independent financial adviser about your requirements and circumstances before taking the plunge. Reading guides such as this can only provide you with a basic understanding of the topic, but an independent financial adviser will be able to go much further into detail and ensure you get the right self-employed contractors' income protection policy at the best price for your personal circumstances. The most important thing is that you come away with a policy that protects you and your family from financial difficulties, and that is what specialist advice will give you.
If you'd like to speak to an income protection expert, please call 01202 714178.
Frequently asked questions
What's the difference between Directors' Income Protection and Executive Income Protection?
Directors' Income Protection and Executive Income Protection are the same things; the latter is the formal name, whereas the former is what many self-employed contractors call it. Sometimes people also refer to it as "Sickness insurance" or "self-employed income protection insurance", but they are all effectively the same and designed to act as a type of sick pay for small business owners.
What is contractor's sickness insurance?
A contractor sickness insurance policy is an income protection insurance that provides you with a regular income if you can't work, minimising financial worries and ensuring you can continue to meet your financial commitments while you get back on your feet. This type of income protection cover is for by your own limited company and is designed to cover up to 80% of your income, both salary and dividends.
Can income protection be paid by the business?
Yes, with a contractor income protection insurance policy, the business pays the premium, not the individual. This has several benefits, not least that the premiums are tax-deductible, so you don't have to pay tax on them.
Are income protection policies worth it?
Yes, income protection insurance is the one type of insurance that every working adult in the UK should consider, according to Which?. Income protection cover is essential for the self-employed, limited company directors and contractors as they all typically have no formal sick pay. Therefore, should they become unwell, their income would soon stop. Contractor income protection insurance allows small business owners to pay for their policy through their limited company, with numerous benefits and tax advantages.
What is excluded from an income protection plan?
Typically all of the following will be excluded from an income protection insurance policy; drug and alcohol misuse, self-inflicted injuries, travel to a country with political instability, internal conflict or an active epidemic.
Can you claim income protection as a tax deduction?
The premiums that the business pays for income protection insurance are seen as a business expense by HMRC and are therefore deductible from your corporation tax bill. These policies aren't typically seen as a benefit in kind and are therefore tax-free.
What is a "deferred period"?
The "deferred period" is the waiting period between you having to stop work and the benefit of your income insurance starting to payout. This waiting period can usually be set at 4, 8, 13, 26, or 52 weeks with self-employed income protection. The longer the deferred period, the lower your premiums will be; however, please be mindful that you will need to support yourself during that time before the policy starts paying you.
Can contractors get an income protection policy?
Yes, and it's formally called Executive Income Protection insurance. With this type of insurance, a business owner can pay for the policy through their company, with many benefits.
How long is income protection paid for?
You can choose how long you would like your income protection pays out. However, in most cases, it's wise to protect yourself up until retirement to ensure that your outgoings are covered right up until you start receiving your pension.
What is the maximum income protection benefit?
With income protection insurance for contractors, you can cover up to 80% of your income, both salary and dividends. Uniquely, if your partner also draws dividends from the business, you can include their income, as long as they are in a non-profit making role.
How much income protection can I get?
If you take out a policy via your business and you're wondering how much income protection you can get, the good news is you can get up to 80% of your monthly income, both PAYE and dividends. There are also many benefits, not least that it's tax efficient.
Is this the same as permanent health insurance?
The way income protection works are that you receive monthly payments to cover your living expenses. It isn't permanent health insurance, as health insurance typically pays for private medical treatment, not a monthly income. Income protection should also not be confused with critical illness cover, a type of life insurance policy.
Is income protection insurance for contractors the same as unemployment insurance?
Contractors' income protection insurance is typically there to protect from illness or injury, not unemployment. Try to think of it more like sick pay for self-employed business owners or contractor sickness insurance.
