Is income protection insurance benefit taxable?

Income protection insurance

August 6, 2015

We’re all used to being taxed to the hilt. Amongst the most hated taxes we have to stump up for here in the UK are the dreaded (but largely unavoidable) stamp duty, inheritance tax, council tax, income tax and VAT.

Essentially we’re taxed today pretty much every time we breathe, eat, sleep or indulge in the things which routinely happen in between.

Why, we’re even taxed when we shuffle off this mortal coil, as many a famous end-of-pier comedian has mused about; the only two things that are certainties in life are death and taxes.

Which while not necessarily mutually exclusive, are unfair bedfellows at the end of all of our days.

However – and as a post note – if a poll was conducted right now to determine just which of the ever expansive range of taxes we’re susceptible to was acknowledged as the ultimate kick in the teeth to our wealth – then we’re guessing that the highly controversial bedroom tax would also figure highly.

Unfortunately the vast majority of popular (not to mention, essential) insurance products currently available on the market aren’t spared the spectre of taxation, whether policyholders like it or not – and income protection insurance is no exception to this general practice.

Whichever way you care to look at it an income protection insurance plan is a purchasable item, and therefore in that capacity is – along with anything else fundamentally bought and sold – liable to have a percentage earmarked by the Treasury from the outset. Whether up front and clear in its intentions, or alternatively by stealth, back-door taxation.

Of course it’s not all cut and dry, and it all hinges on how you have chosen to pay your income protection

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policy as to if and when you are expected to cough up. It augers much better for those policyholders who elect to pay the income protection insurance premiums directly from their personal bank accounts, as in the eyes of the Chancellor of the Exchequer you are using monies to fund this plan which have already been taxed as they’re derived from your net pay.

Yet instead if your company is responsible for paying your income protection insurance as part and parcel of any perceived business expense then in the event of a future claim being made against the policy any subsequent benefit payment received would be taxed as income.

Let’s talk about tax

Yet, whilst at first glance it appears that self-financing any income protection insurance policy via an individual’s personal bank account is the best policy to escape taxation, we wouldn’t advise anyone to get too excited about this. That’s for the simple reason that you’ve previously had an appropriately taxable amount deducted as the monies (i.e, your salary) was paid into your bank account, prior to you then re-directing this figure to an income protection insurance-providing company.

So effectively it’s been taxed at source, rather than at a later date, with the taxman getting his pound of flesh one way or another. But for the purposes of answering this particular headline question, then ‘no’, income protection insurance benefit ISN’T taxable if and when all premiums are paid by the insured party/proposer/policyholder.

On the flip side of this coin, ‘yes’, income protection insurance policy benefits ARE taxable should an employer handle this on behalf of an employee/policyholder in the guise of a legit company perk.

Although this isn’t the end of the story. Confused?

Then let us explain…

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On some occasions income protection insurance plans will be paid by a business, whether the eventual benefactor is an employee of that business or the company’s director, while the self-employed often opt to go down this route. And to mix things up a little more, there are times when the premium can actually be split in terms of who pays for it between the employer and employee.

So, and as a better means of understanding the basic elements of these approaches to income protection insurance, we’ve broken this down into core areas. For example, if the income protection premiums SOLELY by an employer, then any future benefits received by the named party would be subject to taxation as a valid source of income.

However should your employer remain liable for paying the premium – yet the named individual/benefactor settled the tax on these premiums – then any benefits dished out at a later date would NOT be taxed; as essentially the premiums would have been paid out of your (previously) taxed income, if you follow? To put it another way, should the beneficial party have paid all or part of the income protection insurance policy premiums then tax would be levied, in the same proportion, on any benefits received further down the line. Meaning that if you paid 50% of the monthly premium then you’d be taxed on 50% of the benefits paid-out in the long run.

Worth remembering though that should you box-tick the company/employer method of income protection insurance policy practice, then because the premiums are taken care of by the business then the benefits will consequently be paid to the business when a claim is successfully handled and ratified. As a direct result of this protocol then the benefits paid out to you would have to be processed by the company payroll and would then be subject to income tax; presenting itself in the form of either PAYE, Schedule D or Self-Assessment for the purposes of the taxman.

With this in mind – and so as to better align the benefits forthcoming with take home pay – it’s advisable to insure up to 80% of your gross pay in terms of an all-encompassing and far-reaching income protection policy.