Executive Income Protection Covering Dividends and Salary for Directors

How to structure sick pay insurance when your income isn't just a standard PAYE wage

For company directors in the UK, a standard sick pay policy often misses the mark. You’ve structured your remuneration to be tax-efficient, typically a modest PAYE salary supplemented by substantial dividends. But this financial prudence creates a significant vulnerability: if long-term illness or injury strikes, what happens to your income?

Most personal income protection plans will only consider your PAYE salary, ignoring the dividends that form the bulk of your earnings. This leaves a catastrophic gap in your financial safety net, potentially forcing you to deplete personal savings, sell assets, or even risk the stability of the business you’ve built.

The solution lies in a specialist policy designed for this exact scenario: Executive Income Protection. This article provides a definitive guide for company directors on how to use this powerful tool to protect their entire income—salary, dividends, and benefits—in a way that is both comprehensive and exceptionally tax-efficient.

What is Executive Income Protection? A Director's Financial Safety Net

Executive Income Protection is a type of long-term sick pay insurance owned and paid for by your limited company. Its purpose is to provide a regular monthly income if a director or key employee is unable to work due to illness or injury.

Unlike a personal policy, it is set up as a business-level agreement. Here’s how it works in practice:

1. The Company Pays: Your limited company pays the monthly premiums for the policy.
2. The Benefit is Paid to the Company: If you need to make a claim, the insurer pays the monthly benefit directly to your company's bank account.
3. The Company Pays You: Your company then processes this payment to you through its standard PAYE payroll system, just like a salary.

The key advantage is that it’s designed from the ground up to recognise a director’s full remuneration package. Insurers underwriting these policies will assess not just your salary but also your regular dividend income and even P11D benefits to establish a suitable level of cover.

This makes it a far more appropriate solution for directors than a standard personal plan, ensuring the benefit you receive is a true reflection of your lost earnings.

The Director's Dilemma: Why Your Salary and Dividend Split Creates a Protection Gap

As a company director, you've likely been advised that taking a small salary (often up to the National Insurance threshold) and drawing the rest of your income as dividends is the most tax-efficient strategy. This is common and sensible practice.

However, this creates a major problem for traditional income protection:

• Personal Income Protection (PIP): These policies are designed for employees. Insurers will typically only agree to cover 50-70% of your gross PAYE salary. They almost always disregard dividend income entirely.
• The Income Gap: If you earn a £12,000 salary and £88,000 in dividends, a personal plan might only cover around £600 per month (£7,200 a year). This is a fraction of your £100,000 total income, leaving you dangerously exposed.

Executive Income Protection closes this gap by looking at the complete picture.

Personal vs. Executive Income Protection for a Director

Let's compare the two options for a director earning a total of £100,000 (£12k salary + £88k dividends).

While the tax-free benefit of a personal plan seems appealing, the tiny amount it covers makes it inadequate for most directors. Executive Income Protection provides a much larger, more meaningful benefit that truly replaces your lost earnings, even after tax is deducted.

How Executive Income Protection Covers Both Salary and Dividends

This is the central benefit of an executive policy. Insurers that offer this cover have a specific underwriting process to verify a director’s total earnings.

When you apply, the insurer will ask for evidence of your full remuneration. This typically includes:

• P60s: To confirm your PAYE salary.
• Dividend Vouchers: To confirm the dividend income you draw from the company.
• Company Accounts: To demonstrate the business's profitability and ability to pay dividends.
• SA302 / Tax Calculations: From HMRC to provide a complete overview of your declared income.

The insurer uses this information to calculate your total annual earnings. They will then allow the company to insure you for up to 80% of this total figure.

Real-Life Scenario: Protecting a Director's True Income

Meet Alex, the 45-year-old director of a successful graphic design agency.

• Income: £12,570 PAYE salary and £70,000 in annual dividends. Total remuneration: £82,570.
• The Problem: A serious back injury requires major surgery and a 12-month recovery period, leaving him unable to work.
• His Cover: Alex's accountant had advised him to set up an Executive Income Protection policy a few years prior. The policy was structured to cover 80% of his total earnings, with a 3-month deferred period.

The Outcome:

1. After the 3-month deferred period, the insurance policy starts paying out.
2. The insurer pays £5,504 per month (£82,570 x 80% / 12) to Alex's limited company.
3. The company's bookkeeper processes this £5,504 through payroll. Alex receives a net payment into his personal bank account after Income Tax and National Insurance are deducted.
4. This income continues for the full 12 months he is off work, allowing him to cover his mortgage, bills, and family living costs without financial stress. The business also remains stable, as he isn't forced to draw down on company reserves.

Without this policy, Alex would have faced a year with virtually no income, placing immense strain on his family and his business.

Structuring Your Executive Income Protection Policy: Key Decisions

Setting up an Executive Income Protection policy isn't just about getting cover; it's about getting the right cover. A specialist adviser will guide you through several key decisions to tailor the policy to your specific needs.

1. The Level of Cover

This is the maximum annual benefit the policy can pay. As mentioned, this is typically capped at 80% of your total gross remuneration (salary + dividends + P11D benefits). This high percentage is designed to account for the fact the benefit will be taxed when you receive it. The net amount you receive should be broadly equivalent to your usual net take-home pay.

2. The Deferred Period

This is the waiting period between when you first become unable to work and when the policy starts paying out. It's a crucial choice that directly impacts the premium.

• Common Options: 4, 8, 13, 26, or 52 weeks.
• How to Choose: You should align the deferred period with your business's financial resilience. Ask yourself: "How long can the business continue to pay me my full income if I'm not generating revenue?" If your business has strong cash reserves, choosing a longer deferred period (e.g., 26 or 52 weeks) can significantly reduce the policy's cost. A shorter period provides quicker support but comes with a higher premium.

3. The Policy Term

This is the duration the policy will remain in force. It's usually set to expire at your planned retirement age, such as 60, 65, or 68. The benefit payments themselves will also have a term.

4. The Payment Term

This dictates how long the policy will pay out for on a valid claim.

• Long-Term (Full Term): The most comprehensive option. The policy will pay out until you either recover, pass away, or reach the end of the policy term (your retirement age). This provides a robust safety net against career-ending illnesses.
• Limited-Term: A more budget-friendly option where payments are capped at a set number of years per claim, typically 1, 2, or 5 years. While less comprehensive, it provides crucial support during the most common periods of absence.

5. The Definition of Incapacity

This is arguably the most important detail in any income protection policy. It defines what "unable to work" actually means.

• 'Own Occupation' Cover: This is the highest standard of cover. The policy will pay out if you are unable to perform the material and substantial duties of your specific job. It doesn't matter if you could theoretically work in another, less demanding role. For a highly skilled professional like a company director, this is the most appropriate definition.
• 'Suited Occupation' Cover: The policy only pays if you cannot do your own job or any other job for which you are reasonably suited by education, training, or experience. This is a weaker definition.
• 'Any Occupation' or 'Activities of Daily Living' (ADL): The lowest grade of cover. It will only pay if you are so severely incapacitated that you cannot perform basic daily tasks or any work at all. This type of cover should generally be avoided for this purpose.

At WeCovr, we strongly advocate for 'Own Occupation' cover for all our director clients, as it provides the most certainty at the point of a claim.

The Tax Implications of Executive Income Protection: A Major Advantage

The tax treatment of Executive Income Protection is one of its most compelling features for a limited company. It's structured to be highly efficient for the business.

Policy Premiums

• The monthly premiums paid by your limited company are generally considered an allowable business expense.
• This means they can be offset against the company's profits, reducing its Corporation Tax bill.
• For a company paying Corporation Tax at 25%, this represents a significant saving on the real cost of the cover.

Benefit Payments

• When the insurer pays a claim, the funds are received by the limited company. This income is not treated as a trading receipt and is therefore not subject to Corporation Tax.
• The company then pays this money to the incapacitated director via its payroll (PAYE).
• At this stage, the income is subject to the director's marginal rate of Income Tax and National Insurance Contributions, just as their salary would be.

This structure is logical and fair. It ensures the director receives a replacement for their gross income, which is then taxed in the normal way. The tax deductibility of the premiums makes the net cost to the business extremely attractive compared to a personal plan.

Disclaimer: This is general guidance only and does not constitute formal tax or financial advice. Tax treatment depends on individual circumstances, policy terms, and HMRC interpretation, which cannot be guaranteed in advance. Whenever applicable, businesses and individuals should always consult a qualified accountant or tax adviser before arranging such policies.

Is Executive Income Protection Right for Your Business?

This type of policy is a strong fit for a specific demographic. If you answer 'yes' to most of the questions below, it is an option you should be seriously considering.

If you're a freelancer or sole trader operating through a limited company, Executive Income Protection is one of the most effective ways to create a robust sick pay plan for yourself.

Beyond Sick Pay: A Director's Complete Protection Strategy

Executive Income Protection is a cornerstone of a director's financial plan, but it works best as part of a holistic protection strategy. A comprehensive review should also consider:

• Key Person Insurance: While EIP protects your income, Key Person Insurance protects the business itself. It provides a lump sum to the company if a key individual dies or suffers a specified critical illness. This cash injection can be used to cover lost profits, recruit a replacement, or repay business loans.

• Shareholder Protection: What happens to your shares if you die or become critically ill? Without a plan, they could pass to your family, who may have no interest or skill in running the business. Shareholder Protection provides the remaining shareholders with the funds to buy the affected director's shares at a pre-agreed price, ensuring a smooth and fair transition of ownership.

• Relevant Life Insurance: This is a tax-efficient death-in-service policy for directors. The company pays the premiums (as a business expense), and if you pass away, a tax-free lump sum is paid directly to your family or a trust. It's a highly valuable employee benefit that you, as a director, can provide for yourself.

A specialist adviser can help you understand how these different policies work together to create a fortress of financial security around you, your family, and your business.

Common Mistakes Directors Make When Arranging Sick Pay Insurance

Navigating the world of business protection can be complex. Here are some common pitfalls we see directors fall into, and how to avoid them:

1. Relying on a Personal Plan: The most frequent mistake is buying a standard personal income protection policy and only covering the small PAYE salary. This leaves the majority of your dividend income completely unprotected.
2. Misaligning the Deferred Period: Choosing a 4-week deferred period when the business has enough cash to support you for 6 months means you're paying for cover you don't need. Conversely, choosing a 52-week period when you only have 3 months of savings is a recipe for disaster.
3. Ignoring the 'Definition of Incapacity': Accepting a policy with a 'Suited' or 'Any' occupation definition to save a small amount on the premium can render the policy useless when you need it most. Always insist on 'Own Occupation' cover.
4. Forgetting to Review Cover: Your income will hopefully grow over time. Many policies include a 'Guaranteed Insurability Option' or 'Increase Option' allowing you to increase your cover (e.g., after a significant rise in profits/dividends) without further medical underwriting. Failing to use this can leave you underinsured.
5. The DIY Approach: Trying to arrange this cover directly without specialist advice is risky. The structure, tax implications, and interaction with other business policies require expert guidance. An error in the setup could lead to an unexpected tax bill or even a rejected claim.

Working with an independent, FCA-regulated broker like WeCovr eliminates these risks. Our experts understand the nuances of director remuneration and will ensure your policy is structured correctly from day one.

Our Commitment to Your Wellbeing

At WeCovr, we believe that the best claim is the one that never has to be made. While insurance provides a vital financial safety net, proactive health management is the first line of defence.

That’s why we offer all our protection clients complimentary access to our powerful, AI-driven calorie and nutrition tracking app, CalorieHero. By helping you make more informed decisions about your diet and lifestyle, we aim to support your long-term health and wellbeing. It's part of our commitment to providing value beyond just the policy itself, helping you stay healthy and productive for longer.

A healthier you is less likely to need time off work, which is the best outcome for you and your business.

Take the Next Step to Secure Your Income

As a company director, your ability to earn is your most valuable asset. Protecting that asset against the risk of long-term illness is not a luxury—it's a fundamental part of responsible financial and business planning.

Executive Income Protection is the most effective and tax-efficient tool to safeguard your complete income of salary and dividends. Don't leave your financial future to chance.

Contact our team of specialist advisers at WeCovr today. We will provide a no-obligation review of your circumstances, explain your options in plain English, and compare quotes from across the UK's leading insurers to find a well-matched and affordable solution for you and your business.

Sources

• Association of British Insurers (ABI)
• Financial Conduct Authority (FCA)
• GOV.UK
• Office for National Statistics (ONS)
• NHS England