R05 candidates tend to arrive well prepared on personal protection and thin on business protection. The business section is a smaller part of the syllabus, and the questions are among the most predictable on the paper because they always test the same four things: who owns the policy, who pays the premium, who receives the proceeds, and what the tax treatment is.
The four business protection needs
| Need | Purpose | Usual solution |
|---|---|---|
| Key person | Replace lost profits or the cost of recruitment when a vital employee dies or is critically ill | Term assurance or critical illness owned by the business |
| Share or partnership protection | Provide funds so remaining owners can buy the departing owner share | Own life in trust, or life of another, plus a cross option agreement |
| Loan protection | Repay business borrowing on death | Term assurance matching the loan |
| Employee benefits | Provide death in service and income protection to staff | Group life, group income protection, relevant life plans |
Key person cover
The starting question is always ownership. A key person policy is normally owned by and paid for by the business, with the business as beneficiary, because the business suffers the loss.
Sum assured is usually calculated by one of three methods:
- Multiple of salary, commonly five to ten times, quick but crude
- Multiple of profits, applying a proportion of gross profit attributable to the individual
- Payroll or replacement cost, the cost of recruiting and training a successor plus lost profit during the gap
The tax treatment turns on the Anderson principles. Premiums may be deductible where the sole purpose is to compensate for loss of profits, the person is an employee with no substantial shareholding, and the term is short and does not extend beyond their expected service. Where premiums are deductible, the proceeds are a taxable trading receipt. Where they are not deductible, the proceeds are normally received free of tax. Candidates lose marks by claiming both the deduction and tax free proceeds.
Share and partnership protection
Two arrangements appear in questions.
Own life in trust. Each owner takes out a policy on their own life, in trust for the other owners. On death the survivors receive the proceeds and use them to buy the shares. This is the usual recommendation because it is flexible when ownership changes and premiums can be equalised.
Life of another. Each owner insures the others. It works with two owners and becomes unmanageable as the number grows, since four owners need twelve policies.
The legal glue is the cross option agreement, sometimes called a double option. The survivors have an option to buy and the personal representatives have an option to sell. Because neither party is obliged, the shareholding is not treated as subject to a binding contract for sale, so business relief for inheritance tax is preserved. A buy and sell agreement, which binds both sides, destroys business relief and is the classic wrong answer.
For critical illness on shares, a single option is used, giving the ill owner the right to sell but not forcing them out.
Premium equalisation matters where owners are different ages or hold unequal shares, since a younger owner paying more for older colleagues cover can create a gratuitous benefit and possible IHT issues.
Partnerships and LLPs
A partnership has no separate legal identity, so the partnership agreement governs what happens on death, and by default the partnership may be dissolved. Business relief is usually available on a partnership interest at 100%. For an LLP, members hold a capital interest and the same protection structure applies with the LLP agreement in place of a partnership deed.
Relevant life plans
A relevant life plan is a single life death in service arrangement for one employee, and it fills a gap for small firms with too few staff for a group scheme, and for high earners whose pension allowances are already under pressure.
| Feature | Treatment |
|---|---|
| Premiums | Normally deductible for the employer as a staff cost |
| Benefit in kind | None for the employee |
| Benefit payment | Free of income tax, paid via a discretionary trust |
| Pension allowances | Does not count towards the annual allowance or the lump sum and death benefit allowance |
| Restrictions | Death benefit only, no critical illness, no surrender value, must cease by age 75 |
The plan must be written in trust for family or dependants, and the employer cannot be a beneficiary. Controlling directors of an unincorporated business cannot use one.
Group risk schemes
Group life assurance is usually a registered scheme providing a multiple of salary, typically two to four times. Benefits are paid through trustees at their discretion, so they fall outside the member estate. Payments count against the lump sum and death benefit allowance where the member dies before 75, unless an excepted group life policy is used, which sits outside pension rules and is taxed under the relevant property trust regime.
Group income protection pays a percentage of salary, commonly 50% to 75%, after a deferred period of 13 or 26 weeks. Benefits are paid to the employer, who passes them to the employee through payroll subject to PAYE and National Insurance. Premiums are a deductible business expense and are not a benefit in kind, which is a favourite question. Cover often has a limited payment period of two to five years, and a proportionate benefit rule applies to part time returns.
Group critical illness pays a lump sum to the employee, and premiums are a P11D benefit in kind for the employee.
Underwriting and administration points
- Group schemes use a free cover limit, below which members are covered without individual underwriting
- Actively at work requirements apply at scheme entry
- Discretionary trusts are used for group life so benefits avoid probate and inheritance tax
- Business protection cover should be reviewed at every change of ownership, at loan renewal and on entry of a new key employee
The exam checklist
For every business protection question ask, in order:
- Who suffers the loss, the business or the family
- Who should therefore own the policy
- Who should receive the proceeds, and is a trust needed
- Are the premiums deductible, and what does that do to the proceeds
- Is there a supporting legal agreement, and does it protect business relief
Work through those five questions and business protection becomes one of the most reliable sections of R05 rather than the one you hope to avoid.