Hello
from what i understand the payment is tax free, and as you say once the money is used for saving/investment, it becaomes taxable like any other amount of money. See below a bit about tax and insurance protection monies. i get paid a small income protection amount, but do pay tax on it, if my employer would change how they administer the money ie paying tax etc, i could get the tax back or not pay any, as it happens my salaries dept won’t, but with hindsight if i had realised there was this loop hole i would have petered them more earlier to insist.
Further information on the tax treatment of PHI policies [Weblink]
Exempt benefits
Permanent Health Insurance (PHI), also known as Income Protection Insurance (IPI) and other names, can be taken out by individuals. It will provide them with income if they’re unable to work as a result of ill-health or disability, or even redundancy. Where a claim is made on the policy, any amount paid out is tax-free by virtue of a special exemption, s.735 of the Income Tax (Trading and other Income) Act 2005 (ITTOIA).But what’s the tax position if an employer takes out a group scheme and pays the premium as a benefit-in-kind (BiK) for their employees?
Taxman’s guidance
The Taxman’s guidance on PHI/IPI is not very clear. But we can say for certain that the exemption mentioned above is extended to employees who benefit from a policy taken out on their behalf by their employer (s.743 ITTOIA 2005). So you would expect a pay-out on a policy to be tax exempt. But there’s a catch.
Taxman’s advice
The Taxman’s instruction manual at IPTM6120 says “…If it [the premium] were taxed as a benefit the employee would have, in effect, paid the premium out of taxed income. Payments received under the policy would therefore be exempt.” But what does this mean in plain English?
Taxable or not taxable?
Trap. The tax-free status on PHI/IPI pay-outs is lost where tax relief is allowed to the insured (the employee). If an employee doesn’t pay tax on the premium as a BiK, then they’ve effectively received tax relief. And as a result, they will have to pay tax on money they receive from the policy. What if the employee pays tax on the premium as a BiK?
Tip. Where an employer pays a PHI/IPI premium for an employee who is then charged to tax on it as a BiK, there will be no tax to pay on the income received if the policy pays out.
Good news - bad news
It seems that one way or the other the Taxman is going to get his pound of flesh. But we think there’s a neat solution to reduce the tax payable. Tip. PHI/IPI policy premiums are due in advance. Therefore, you can use hindsight to decide whether to declare PHI/IPI premiums for employees under a group scheme as a taxable BiK. That way you can choose the most tax-efficient option.
Example. Assume on May 1 2009 you pay the premium renewal for all your employees included under a group PHI/IPI scheme. It averages out at £1,500 per employee. If no one claims under the policy by the end of the tax year, you can ignore the premium when the time comes to declare BiKs on form P11D in July 2010. Therefore, no employee has to pay tax on the premium. But now assume that one of your employees falls ill in November 2009 and can’t work. They claim £7,500 on the policy up to the end of the tax year. When it comes to filling in their P11D you can include the premium, just for that employee, as a BiK. As a result they will not be taxed on the £7,500 but only on the BiK of £1,500. Tax is avoided on £6,000!
The next step
For more information on the tax treatment of PHI policies, visit tax.indicator.co.uk (TX 09.14.03).
Reporting premiums as a benefit-in-kind on form P11D will mean policy pay outs are tax-free. But they will be taxable if premiums are left off. Leave the decision until after the tax year has ended and then choose which option is the most tax efficient.
