Income protection for the self-employed: why it matters and how to set it up right
Being self-employed offers freedom, flexibility, and control over your own future, but it also means that you are the business. If illness or injury prevents you from working, there’s no employer to fall back on. There’s no statutory sick pay, leaving little option other than claiming for Employment and Support Allowance (ESA).
That’s why income protection is one of the most important forms of insurance for self-employed professionals, yet one of the most overlooked.
Why self-employed professionals need income protection
- No sick pay safety net. Many employees have access to sick pay schemes as part of their employment contract. Self-employed people don’t. If your self-employed clients can’t work, their income usually stops immediately. For many, a few weeks without income can have a significant impact, and several months could be financially devastating.
- Limited state benefits. Statutory benefits such as Employment and Support Allowance (ESA) are means-tested, modest in amount, and could be slow to access. They’re unlikely to be enough to cover basic living expenses, especially if clients have a mortgage or dependants.
- Ongoing business costs. Many self-employed individuals face ongoing business costs even when they’re unable to work, such as rent, equipment leases, and vehicle leases. Without income protection, those costs must still be paid, eating into savings or creating debt.
- Flexibility and control. A well-designed income protection policy provides regular monthly payments if they’re too ill or injured to work. These payments can be tailored to their personal and business situation, helping your self-employed clients maintain financial stability until they’re ready to return to work.
Understanding income protection
Income protection is designed to pay out a monthly benefit to replace a portion of your client’s lost income if they’re unable to work due to illness or injury.
Most providers will offer cover up to 50–65% of the client’s regular income (before tax). The reason for not covering the entire lost income is to strike the balance between replacing earnings and maintaining an incentive to return to work.
Before the policy starts paying, it’s necessary for a period of time to elapse, known as the deferred period, this is often 4, 8, 13, 26, or 52 weeks. Shorter periods can mean higher premiums, but faster payouts.
When setting up an income protection policy, the benefit term is how long payments will last, typically 1, 2, or 5 years, or until their chosen retirement age (such as 65 or 68).
Income protection for sole traders
If you have clients who are a sole trader, their insurable income is typically their net profit before tax. Some insurers also include ongoing fixed costs that would continue if your client was unable to work.
Since there’s no company structure, policies must be owned personally, and premiums are paid from the client’s after-tax income. Benefits are paid directly to the client.
Income protection for limited company directors
If you have clients that operate through a limited company, their insurable income is generally based on their salary plus dividends. Most director-shareholders pay themselves a small salary and take the rest as dividends, and many insurers will accept this full picture when calculating benefits.
Though directors are technically employees of their company, most income protection policies in this context are set up personally. That means:
- The director owns the policy
- Premiums are usually paid from personal funds (or reimbursed by the company as remuneration)
- Benefits are received personally and are tax free
While some executive income protection plans exist (with the company paying the premium and the benefit treated as taxable income), most standard policies for directors are structured as personal policies for simplicity and tax-efficiency.
Top tips for the perfect income protection policy
- A 13- or 26-week deferred period balances affordability and speed of payout for most. Clients with emergency savings may opt for 26 weeks to reduce premiums.
- Aim to cover at least your client’s monthly household expenses and fixed business overheads. Remember, over-insuring may result in claim reductions, so keep benefits realistic.
- For younger clients, covering to retirement (for example, age 65 or 68) offers peace of mind. For older or budget-conscious clients, a 2- or 5-year term may be suitable.
- Inflation-linked increases protect long-term value. Fixed-rate indexation (for example, 3% annually) or RPI-linked options are both commonly available.
Tax treatment
Generally, premiums for personally-owned income protection policies are not tax-deductible, regardless of whether you’re self-employed or a director.
Any claim payments received under a personally-owned policy are tax free. If the company owns the policy and pays the premiums, the tax treatment becomes more complex, potentially a taxable benefit.
Why Royal London?
With our Income Protection, you can cover up to 65% of the first £60,000 of your client’s earnings and 50% of income above that, up to £250,000. Additionally, fracture cover and hospitalisation support payments are included at no extra cost.
For self-employed clients, they can include ongoing fixed business expenses such as rent or finance agreements.
Limited company directors can include both salary and dividends in their insured income.
Clients only need 12 months of financial history to verify their earnings which is ideal for newer businesses.
And for contracting clients, they can benefit from a three-month grace period, allowing them to maintain their own occupation status if they’re not working or are in between jobs at point of claim.
Income protection may not be the most glamorous financial product — but for self-employed people, it’s often the most essential. It protects their lifestyle, their home, their business and their independence.
With no sick pay or employer safety net, the question for self-employed clients isn’t ‘can I afford income protection?’, it’s ‘can I afford to be without it?’.
