protecting your business clients

Lavender Insurance is a trading style of pi financial ltd, Chartered Financial Planners, Company Number 3556277, which is authorised and regulated by the Financial Services Authority. pi financial ltd is registered in England, registered address Morfe House, Belle Vue Road,Shrewsbury, SY3 7LU.

what’s it all about?

Protecting businesses against:

• the effects of the loss of a key person on profits and on availability of business loans

• losing control of the business after the loss of a partner or shareholder

who needs protection?

• Companies:– mainly small or medium– some large ones too– key employee cover– loan cover

• Individuals:– partners– shareholders– sole traders

Brian MarshManaging/Technical

MJE Technology Ltd – directors An Example Case Study

David JonesSales

Peter EdwardsFinancial

how likely are they …

to die before age 65?

Based on 70% of TM92 ultimate mortality UK Government Statistics Office

Age

1 2 3 4 5 10

30 8% 15% 21% 27% 33% 55%

40 7% 14% 20% 26% 31% 53%

45 7% 13% 19% 25% 30% 51%

50 6% 12% 18% 23% 28% 48%

Number of lives

the problem

• Companies don’t plan for the future– who will take control if the unexpected happens?– how will the business be run?– how will they cope with the financial effects?

• How about your own business?– what would happen to it if you could not work?

what happens to the company?

• Effects on business viability– bank– cash flow– creditors– customers

• Day-to-day management

• Lack of a key person, partner and major shareholder – rest of the team is over-worked, stressed

…and to their family?

the market potential

• The business protection gap in the UK is about £1.1 Trillion

• Nearly half of private limited firms have no key person insurance to cover directors, loss of earnings or loan cover

• 42% of partnerships have no protectionSource: Legal and General/British Chamber of Commerce 2009

key person cover

key person cover

• ‘Profit protection scheme’

• Protects the company against the death or illness of a key employee

• Must be flexible:– people leave and change roles– businesses grow, new people join – the key person’s value may increase over time

identify … the key employeesa sample case study

• Managing Director• Plus?

– other directors– project leaders– department heads

• Anyone:– who would be hard to replace, and – whose absence would have a serious financial effect

on profits

how is key person cover set up?

• Policyholder or owner the company

• Life assured the key person

• Who gets the benefits? the company

• Written in trust? no

• Tax:– company possible if tax relief

taken on premiums– key person none

Key person and loan cover

Who owns the policy?

• Limited companies – public or private:– the company is a legal entity– it can be the policyholder

• Partnerships– many partnerships are not legal entities– so they cannot be the policyholder– except for partnerships in Scotland and those set

up under the Limited Liability Partnerships’ Act 2000

how to set up the cover for partnerships

• Each person has an ‘own life’ policy– they are both policyholder and life assured

• The policy is written in trust for the other partners– discretionary business trust – partners receive the

benefits• Need a legal agreement that all payments will be

used for the benefit of the partnership• If the partnership pays the premiums, they are

deducted from the partner’s share of the profits

business loan cover

business loan cover

• Protects a company against the loss of a key person or guarantor

• Enables repayment of the loan should they die or get a critical illness

• Can be assigned to a lender

• Should be flexible for future changes

how could it affect their family and home?

who should be covered

• Anyone whose long-term or permanent absence would affect the business’s ability to repay its borrowings

• Anyone who is a guarantor of the loan

how is loan cover set up?

• Policyholder or owner the company

• Life assured guarantor or key person

• Who gets the benefits? the company

• Written in trust? no

• Tax:– company no relief on premiums;

no tax on benefits– life assured none

partnership or shareholder cover

partnership or shareholder cover

Protection for:

• The firm’s future– control in the right hands

• The partner or shareholder’s family– making sure the right people have the cash at the

right time

• All the major shareholders

The other 2% is split between several long-standing employees

who should be covered A sample Case study

48% 30% 20%

how is partnership/shareholder cover set up for two or three people?

• Policyholders or owners the other partner(s) or shareholder(s)

• Life assured(s) the partner or shareholder

• Written in trust? no

• Who gets the benefits? the policyholder

• Tax implications none

• Company/partnership noneinvolvement

cover for two or three partners or shareholders

Advantages:• it’s simple – no trust needed

• no potential IHT charges on a trust

• no tax implications; the business is not involved

Disadvantages:

• potential problems if the business grows

• less flexibility to cover more partners or shareholders

cover for MJE Technology

Policy A

Policy B

Policy C

Life assured

Life assured

Policyholder

Policyholder

PolicyholderPolicyholder

Policyholder

Policyholder

Life assured

cover for larger businesses

With more than three partners or shareholders:

• each person takes out a policy on their own life

• written in trust for the remaining partners or shareholders

• a discretionary trust allows for future changes to the business’s structure

• the policies can all be written in one plan for one person to look after

how is partnership or shareholder cover set up for larger businesses?• Policyholder or owner the partner or shareholder

• Life assured the partner or shareholder

• Written in trust? yes – discretionary business trust

• Who gets the benefits? the trustees, for the beneficiaries

• Tax implications potential

• Company or nonepartnership involvement

writing business protection in trust

• Not as simple as it used to be

• Periodic charges– introduced in the Finance Act 2006– for discretionary trusts

• Pre-owned asset tax– if the settlor is included as a potential beneficiary

choice of trusts

Business assurance trust:

• flexible for future business changes and growth

• beneficiaries are the partners or shareholders at the time

but

• subject to Finance Act 2006 rules on IHT

• potential entry, 10-year periodic and exit charges

choice of trusts

Absolute or bare trust

• not subject to 2006 IHT rules

• no potential entry, 10-year periodic and exit charges

but

• inflexible – beneficiaries are set at outset and cannot be changed

• less suitable for businesses whose shareholding might change in the future

the Rysaffe principle

• Use a discretionary trust with its advantages for businesses

• Split the cover between multiple policies– each has a sum assured lower than the current IHT

nil-rate band (NRB)– written under a separate trust on different days– considered to be separate arrangements

• Decreases the possibility of future charges

how the Rysaffe principle works

• Client needs £1 million cover

• Current NRB = £300,000

• Cover split between four policies

• Each policy has its own NRB

• Sum assured for each = £250,000 – less than NRB

• There should be no future charges

the Rysaffe principle

Advantages

• Reduces the possibility of future charges

• retains flexibility for future changes in the business

the Rysaffe principle

Disadvantages and risks

• more paperwork to set up – four separate trust documents

• possible extra cost due to loss of large case rates

• for unit-linked plans, asset growth could outstrip increase in NRB

• benefits may be minimal for very large sums assured

• rules might change retrospectively in the future

pre-owned asset tax

Introduced in 2004 Finance Act

• before then, gift with reservation provisions did not apply to commercial arrangements

• applies to business assurance trusts:– where the settlor is included as possible beneficiary– valuation rate of 6.25% to calculate deemed benefit– no tax if value of all deemed benefits is £5,000 or less

a year– otherwise value of deemed benefit added to taxable

income

pre-owned asset tax (POAT)

Include settlor as potential beneficiary:

• POAT may be payablebut

• whole life policy can be assigned back to settlor on retirement

• they may be unable to get further cover due to age or health

Exclude settlor as potential beneficiary:

• avoids potential POAT

but• can’t assign policy to

settlor

taxation

• premiums are not normally tax-deductible

• benefits are paid free of corporation or income tax

• pre-owned assets tax should not apply if the settlor is excluded as a potential beneficiary

• potential for IHT charges if written in trust

Shares

Cross-option agreement

Will

cross-option agreement

Brian Marsh

Life cover

Sarah Marsh

Shares Cash

Death benefit

David Jones and Peter Edwards

Cross option agreement definition

• Shareholders that survive have an option to buy ("call") the shares from the departed shareholder's representatives, and executors of the deceased shareholder have an option to sell ("put") the shares to the remaining shareholders. If the surviving directors decide that they want to buy the deceased shareholder's shares then the deceased estate must sell them. Similarly, if the shareholding is offered to the surviving shareholders then they have an obligation to buy. It could be that neither party exercises their option there is no binding sale and business property relief for inheritance tax purposes is preserved. The agreement must specify the method of valuing the shares and the time limit for exercising the options. Some life assurance companies will provide a specimen standard wording for a cross option agreement. It is still advisable for both parties to take legal advice to ensure that the agreement meets their requirements and it may be better to have a customised agreement drawn up, even if that entails higher legal fees.

the types of cover

Key person cover

The company

Loss of profits and costs of replacing a

key person

against

protects

Business loan cover

Effects of loss of a key person

on its loans

The company

protects

against

Shareholder or partner

protection

Remaining shareholders/partners

Shareholder/partner’s family

Provide cash to buy shares

for

to

• This presentation is based on Lavender Insurance interpretation of the law and HM Revenue & Customs practice as at 1 September 2010.

• While this interpretation is believed to be correct, Lavender Insurance can give no guarantee in this respect.

• Lavender Insurance is a trading style of pi financial ltd, Chartered Financial Planners, Company Number 3556277, which is authorised and regulated by the Financial Services Authority. pi financial ltd is registered in England, registered address Morfe House, Belle Vue Road,Shrewsbury, SY3 7LU.

If you would like further information or a chat you can contact us anytime

Address 4th Floor12 Renfield StreetGlasgowG2 5AL

Telephone 0800 000 0000*Fax 0800 000 0000Email tom@lavenderinsurance.co.uk

Lavender Insurance is a trading style of pi financial ltd, Chartered Financial Planners, Company Number 3556277, which is authorised and regulated by the Financial Services Authority. pi financial ltd is registered in England, registered address Morfe House, Belle Vue Road,Shrewsbury, SY3 7LU.*Calls to this number may not be free from all telephones