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Is income protection taxable?

Income protection insurance is a great policy to have in place, with regular pay outs if you are unable to work due to illness or injury.

According to figures from the Office of National Statistics, around 2.5 million people were reported to be out of work due to long term sickness between June and August 2022. If unable to work due to illness for an extended time, affording your monthly bills will be a major worry for many.

Income protection policy pay outs work as a replacement for your regular monthly salary – so you might wonder whether you will be taxed on this payment in the same way.

In this guide, we are looking at income protection and whether tax will apply to the benefit from your policy.

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Income protection is a widely available insurance policy. It works as additional financial security, ensuring you will be able to pay your monthly bills if off work due to injury or illness.

If you are signed off sick from work and cannot receive your usual income, income protection covers you in this situation and the policy will pay you a lump sum each month. This will replace anywhere between 50%-70% of your monthly pre-tax salary and can be used to cover expenses such as:

  • Rent or mortgage payments
  • Utility bills
  • Finance payments (e.g. credit cards or car finance)
  • School fees
  • And more…

This particularly helpful if you are self employed, a contract worker or own your own limited company and don’t have access to other means of support such as statutory sick pay (SSP). The level of cover you have is also flexible, meaning you can choose your policy based on a budget that is affordable fot you.

Is income protection a taxable benefit?

NO – if you have a personal income protection policy (one you pay for yourself), your payments will be tax-free. You also will not have to pay national insurance on this amount.

This can be extremely helpful, meaning you have additional funds available at a time you greatly need them.

Currently, as long as you are paying for income protection yourself through a personal bank account, you shouldn’t be taxed on the claim payments.

YES – if your income protection plan is tied to a group scheme, it is possible that you could be liable to be taxed on your payments. With this type of income protection, your employer pays the premium on your policy, and they will receive the pay out and use this to pay you as a replacement for your usual wages.

There can be some confusion as the money paid from the insurance company to your employer is tax-free. However, once the employer has this money and then uses it to pay you, the funds can be taxed as normal income.

Whether you will be taxed depends on factors like the specifics of your policy if you contribute to the payments yourself at all and more. In many cases, you will likely be taxed as you would receive the payments from your employer in the same way you receive your usual monthly income.

Tax rules can change over time so if you are unsure, it is always best to check where you stand with your employer or a financial advisor.

What if my employer pays for my income protection insurance?

If you are a high earner in an important position in your company, your employer could decide to take out what is known as ‘executive income protection’ on your behalf. This is commonly used for company directors, CEOs and anyone whose absence from the business would cause major disruption.

As this policy will usually be a workplace benefit where the premiums are paid for by the company, your policy will pay out to your employer who will then use these funds as a replacement for your regular income. They will then pay this money to you in the way you would receive your usual income e.g. Pay As You Earn (PAYE).

As the money is being paid to you through a business, your payments will usually be taxed in the same way your monthly income would be. The only way this wouldn’t be the case is if you paid for part of the premiums yourself which covers the taxable amount.

Even though this policy is a perk of the job it could be more beneficial for you to pay for your own individual policy, as these are not tax liable.

YES – a big selling point for business owners is that employee income protection schemes can be written off as a business expense. This means they can offer an attractive benefit for their employees, with the added bonus that HMRC approve this as a tax-free expense.

Income protection policies are not classed as P11D benefits or ‘benefits in kind’ meaning that although the payout from a group income protection claim for example may be taxable, the premiums should not be.

If you have a personal income protection policy, you won’t be taxed on any pay outs received from this policy. This means you can benefit from the full pay out amount to support yourself until you are able to return to work again.

Useful resources

Gov.uk – Income Tax Rates and Personal Allowances

Citizen’s Advice – Getting tax advice

Gov.uk – Get help with tax

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Is it worth having income protection insurance?

Income protection insurance can be extremely useful and very important for anyone who is unable to work due to sickness or an injury (e.g. from an accident, sports, work etc.). Essentially, income protection insurance pays out monthly to replace any lost earnings while you are unfit or unable to work.

Payments for income protection insurance can be used to pay your mortgage, rent, other credit commitments, food bills, utilities and other regular outgoings.

Common myths about income protection insurance:

  • Income Protection Insurance won’t pay out
  • Statutory Sick Pay (SSP) from the government will cover me
  • The cost of Income Protection Insurance is high
  • People with medical conditions can't have Income Protection Insurance
  • My employer will help support me
What does income protection insurance cover?

As a rule of thumb, income protection insurance will pay out a regular monthly tax-free payment to you if you can’t work and you are signed off by a doctor. You will need to provide supporting evidence from a medical professional such as your GP and proof of income from your employer or accountant.

Example: Sarah was involved in a car accident which resulted in a serious back and neck injury that prevented her from being able to drive for 6 months. She was able to claim on her income protection policy after 4 week for the remaining 5 months until she was able to move and drive again. She would also usually be able to claim for rehabilitation and physiotherapy to help her to return to work as planned.

Do I need income protection insurance for a mortgage?

Income protection insurance and mortgage life insurance are not compulsory for getting a mortgage in the United Kingdom. Some mortgage lenders might ask for you to get insurance as a condition of the mortgage offer in some circumstances but this is rare.

It is strongly recommended to have insurance to protect you and your family if you have a mortgage and other credit commitments. If you consider what the financial impact would be if you were unable to work due to accident, sickness or injury, and even if you were to die.

Most common mortgage protection insurance policies:

  • Buildings insurance
  • Mortgage life insurance
  • Income protection insurance
  • Critical illness insurance
  • Mortgage payment protection insurance (Accident, Sickness & Redundancy
Is income protection insurance tax free?

Payments from an income protection insurance claim are almost always tax-free, apart from some business income protection policies. This is because you pay tax on the premiums for personal income protection insurance at source (i.e. the premiums are paid from your net monthly salary).

The same applies to life insurance premiums and payouts, effectively you have already paid tax on the premiums that you have paid. There are some other possible tax implications that may apply in certain circumstances so you should seek proper advice or guidance if you have any specific questions.

Which is the best income protection insurance UK?

It’s very difficult to say overall which income protection insurance policies or providers are the best, simply because there are so many different options and types of cover. You can get income protection insurance from an even wider range of insurance providers than life insurance, so your choice is even greater.

The most common income protection insurance policy is:

  • Short term income protection insurance (24 months)
  • 4-week deferred period (pays out after 1 month of absence)
  • Guaranteed premiums (fixed premiums)
  • Underwritten income protection insurance

There are several other cover options for income protection insurance (e.g. long-term, age rated, reviewable premiums, guaranteed acceptance and 0 weeks to 12 months deferred periods).

The top 5 income protection insurance providers according to research by Defaqto are:

  1. Aviva (Trustpilot score: 4.0 out of 5.0)
  2. British Friendly Society (Trustpilot score: 4.1 out of 5.0)
  3. LV= (Trustpilot score: 4.5 out of 5.0)
  4. Royal London (Trustpilot score: 4.0 out of 5.0)
  5. Shepherds Friendly (Trustpilot score: 4.3 out of 5.0)
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