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Relevant life policies versus Key person insurance – explained

Contractors seeking to protect their business and family should understand that a Relevant Life Policy (RLP) and Key person insurance are not the same thing.

Each protection insurance brings a range of different benefits, so contractors need to choose the right product for their needs.

Both Relevant Life Policies and Key person insurance are life insurance policies, but RLP’s benefit the contractor’s family whereas Key person insurance benefits the contractor’s business.

Contractors who have existing Key person policies that they may have been mis-sold the product: Unless a contractor has an ambitious growth plan for their contracting business and has fellow directors or employs senior staff, a Key person policy is not generally the right protection product for a single person contractor limited company.

What is Key person insurance?

Approximately 1 in 5 men, and 1 in 6 women, will suffer a long-term illness in their lifetime. The average age for critical illness claims is only 47 years old. And senior employees who suffer serious illness such as a heart attack or stroke may not return for many months or years, if at all. Illness or untimely death of a business principal can place a huge financial burden on a small business.

If a key individual within a business were to suddenly fall ill or suffer an untimely death, then Key person insurance is there for the company to protect itself against the loss of that key employee.

What typically happens in small businesses is that if a director or partner falls ill, they still expect to draw an income from the business that their co-directors or partners are continuing to run.

At the same time, the business will most likely need to hire someone to replace the director, meaning it has to pay out two salaries. The business may also have other outgoings, such as loan repayments.

The Keyman insurance would make a contribution to the cost of the director/partner’s replacement until they are well enough to return to work. Some companies choose both Keyman insurance and critical illness for the individual too ill to work to help spread the costs.

How does Keyman insurance work?

A Key person policy is designed to mitigate the financial impact on the business resulting from the loss of a key business principal or employee. As a result, any payouts are directly from the insurer to the business, and not the contractor or their family.

The insurance is not designed to replace the sales and profits that might be generated by the missing individual, but it could contribute towards the training and salary of a replacement for a defined period of time. It could also cover other outgoings, such as loan interest, if the director were to pass away.

As with all protection insurance, a contractor would discuss their needs and risks with a financial adviser to identify what outgoings require protection. The policy and premiums would then be tailored accordingly, and as a legitimate business expense the premiums would benefit from corporation tax relief.

How a Relevant Life Policy is different from Key person insurance

In contrast, a Relevant Life Policy (RLP) is designed to benefit a contractor’s family and ideally a contractor planning to grow their business would have an RLP and Key person insurance working together.

In the event of the contractor’s death, the proceeds of the RLP will go to the estate of the person insured or would be set up in trust and go to the contractor’s beneficiaries tax efficiently.

RLPs are set up and paid for by a contractor’s limited company and are usually eligible for corporation tax relief. We would also recommend a critical illness policy, as RLPs only pay out when the insured person dies, not if they are too ill to work.

Are you a team of one?

The lump sum payment your company will receive from the key person cover will allow you time off work to recuperate without the need to worry about money. You’ll continue to trade, cover your mortgage, pay household bills or make alterations to your home or lifestyle to allow you to adjust. This plan also safeguards any savings you have accumulated over the years (and paid tax on!).

Updated: 26 October 2023

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