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Shareholder protection insurance provides financial protection to your business
Shareholder protection usually comes in two forms: life insurance and critical illness cover. The purpose of these policies is to give the shareholders enough money to buy the shares of another shareholder if they become critically ill, or from their next of kin if they pass away.
There are a couple of ways to set these policies up and they each have their pros and cons, especially when it comes to taxation. There are lots and lots of things to know about shareholder protection and this page goes over some of the main points you should consider when taking out this insurance.
Our advisers will find the right shareholder protection policies for you and your business.
Shareholder Protection: Cross-Option Agreement
A shareholder cross-option agreement is one of the main ways to arrange shareholder life insurance.
Some key points:
- Each shareholder arranges their own life insurance policy that is placed into Trust for the other shareholders
- The policy is often arranged on a 5 yearly or 10 yearly renewable contract
- The life insurance is paid for by the shareholders
- Each shareholder then pays towards the cost of the other shareholders policies, potentially as a P11D benefit (don’t worry I’ll explain this more)
This is what usually happens, there is a slightly different route that I will explain at the end of this section.
That last bullet is a technical thing that your accountant will work their magic on, but as a business owner myself I know that you will want to understand how it works. Let’s go through an example together.
CuraExample Ltd has two shareholders, Mr P and Mrs M. They need shareholder protection so that if either of them pass away that the other person can buy their shares from their next of kin. Mr P and Mrs M each arrange a life insurance policy that is placed into Trust for the other.
This means that if Mr P dies then Mrs M receives the money from the insurance and then pays this money to Mr P’s next of kin to buy the shares. By using a cross-option agreement if Mrs M wants to buy the shares and/or the family want to sell the shares to Mrs M, the transaction has to take place. When one part triggers the cross-option agreement, both parties must take part.
So because Mrs M will receive the funds from the life insurance policy, she actually pays the premiums for Mr P’s shareholder protection. Mr P in turn pays for Mrs M’s shareholder protection cover, as he would receive the funds upon her death.
I hope that the above example has helped. The same concept applies when you have more shareholders. If you are a firm of 4 shareholders, then 3 of you will pay the premiums for 1 person, as the 3 of you will receive the funds from the shareholder life insurance policy for that person. This is known as premium equalisation. If you do not do this premium equalisation then HMRC might see the insurance payout as a gift, which will not help you achieve your goals.
Slightly different route:
- Each shareholder arranges a life of another policy for each of the other shareholders
This option gets messy when you have more than two shareholders. This is because not only are the shareholders paying for the insurance for the other shareholders, there also individual life insurance policies being arranged for each person too.
If we look at a company that has 5 shareholders, arranging the shareholder protection the first way I went through leads to 5 shareholder life insurance policies in total. If all of the shareholders wanted to set up the shareholder protection under a life of another route there would be 20 life insurance policies arranged.
Shareholder Protection: Company Buy Back
Shareholder buy back works in a different way and it can be very very tempting as the premiums are paid for by the Company and not by the individual shareholders, but you must understand some key parts of this.
- Each shareholder has life insurance arranged and owned by the Company
- The policy is often arranged on a 5 yearly or 10 yearly renewable contract
- The life insurance is paid for by the Company and cannot be offset against corporation tax
- Upon a successful claim being paid it can be classed as a capital receipt (this is the thing to seriously consider)
So upon a shareholder’s death the other shareholders buy the shares from the next of kin and must then immediately cancel those shares. A statement would need to be published in the Gazette for potential creditors to see. The passing of the shareholder might lead creditors to ask for repayment of their investment, which could potentially use up some, all or more funds than the life insurance has paid out.
This option can be the right solution for you, the premiums being paid for the Company certainly stands out as a favourable route. It’s just important to be aware that if you do have any creditors that the funds received from the insurance policy might to achieve what you want it to.
Shareholder Protection: Buy and Sell
This is a potential option, but it’s not often used as it can lead to inheritance tax issues. HMRC views this as option as the shareholder having left cash in the Company for their next of kin, rather than shares.
With this option business property relief is denied. This form of shareholder protection is not generally used for these reasons.
Shareholder Protection: Critical Illness Cover
A critical illness policy pays out if a person has been diagnosed with a condition that is covered by their insurance contract, often a specific severity.
Critical illness cover can be arranged in a similar way to the cross-option agreements for life insurance that I detailed above. But there needs to be a good discussion between all the shareholders about expectations of what they want the insurance to do.
By using a cross-option agreement if a shareholder is diagnosed with a critical illness, they can themselves trigger that they want the other shareholders to buy their shares and for them to step away as a shareholder. However, the person might want to carry on working and there could be the somewhat negative situation where the other shareholders use the cross-option agreement to trigger the purchase of the shares and removal of the shareholder.
Remember, the cross-option agreement gives either party the right to force the agreement and the other party must comply. There can be significant tax implications if the agreement is forced in this way.
For this reason a single-option agreement might be chosen for shareholder critical illness cover, where the person cannot be forced to sell their shares. There is also a double-option agreement but we are going into lots of technical terms here and it’s better to talk about these options with your specific company details, so that we can make it make more sense.
There are sometimes other options that can be looked at if you are not able to arrange life insurance or critical illness cover through the usual shareholder insurance routes. It can be quite a complex process, far too much insurance jargon to write here, and we would need to work alongside your solicitors to get everything sorted.
They key thing is that even if you have found it tricky to get shareholder protection in the past, it’s always worth chatting to one of our team to double check if we can access insurance for you.
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