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Tax on income protection

Tax on income protection

9 Aug 2021

Tax is always an interesting topic to cover - said no one ever! Despite its pretty dull rep, the tax that you are paying is actually really important to understand. The vast majority of working adults in the UK pay tax and whilst we may resent it, taxpayer’s money keeps our society ticking along. It allows us to be looked after by our incredible NHS, provides a fantastic education system for our children, is invested in things like housing and transport and much, much more.

We pay tax on more things in life than we probably realise. And yes - even our life insurance products can be taxed. But there is a bit more to it than that. Let us explain.

Do I pay tax on my income protection payments?

Despite the statement we just made, if you took out your income protection policy yourself and pay the premiums each month, then you will not pay tax on the payments that you receive from your policy upon a claim. 

That’s because, from the taxman’s perspective, you’ve paid the premiums yourself from your net income at the source. The policy has effectively already been taxed because your income is taxed. This is why most insurers generally only allow you to insure 65% of your gross income, as it works out approximately the same as your net income.

If you have income protection as a benefit in your employment package, it’s usually your employer that will be paying your monthly premiums. In this case, they are usually a tax-deductible business expense. This means that they are a cost that can be subtracted from a company’s income before it is subject to tax. Due to the policy being taxed at the payment stage, it is then generally taxable as income on a claim. So, in this instance, you will pay tax on your income protection payments.

What if my employer and I share the cost of the premiums?

In a slightly more complex case, it is possible that you and your employer might share the cost of the income protection premiums. Let’s say that your employer pays 75% of your premiums and you pay the remaining 25%. If you receive a payout, you would pay tax on 75% of the total payment. The proportion that you pay from your income would not be taxed.

If you do have an income protection policy as part of your employment package, it’s always worth speaking to your employer about how it works and the tax implications of this.

Ultimately, if you don’t want to pay tax on your income protection payouts, then it could be better to take out a policy yourself, separate from your employer, and pay the premiums from your own wage. That being said, even though you may pay tax on your payouts if your policy is through your employer, you may not be paying out for the premiums each month. At the end of the day, it all balances out.

No one said that understanding tax was easy. If you have any more questions about income protection and tax, we are more than happy to help. Give us a call on 0800 316 7253 and have a chat with one of our expert advisers.

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