Cover to consider when paying dividends

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Scottish Widows
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Supported by
Scottish Widows
Cover to consider when paying dividends
Credit: Steve Johnson via Pexels

Aj Somal, chartered financial planner at Aurora Financial Planning, warns that clients who pay themselves through dividends may struggle to protect their incomes during the pandemic as their earnings may vary. 

He says: “It can be difficult for clients who pay themselves via dividends as their earnings tend to vary, particularly during this Covid period. Clients could be paying for cover that they may not be able to claim for, due to their variation in earnings. But insurers need to understand that clients paying dividends would have a varying income over a number of years.” 

When it comes to the obstacles to getting clients protected and evaluating whether income protection or personal sick pay (PSP) works best for most individuals, Somal argues that although IP may cost more, it is more comprehensive and therefore is the better solution for the majority of workers. 

While your salary might cease – depending on the employment contract – your dividends do not necessarily cease.--Scott Gallacher

Somal adds: “l think IP is the best option for most people, as the benefit level can be paid until retirement, compared with a limited payment period of PSP.

“IP tends to cost more, and if the career changes or a significant level of earnings change, then the cover needs to be reviewed and full medical underwriting is required. PSP tends to have less medical underwriting and is a cheaper form of cover, however, the benefit levels tend to be term restricted.”

Although IP may suit many workers, there are still pitfalls to take into account. 

Interestingly, Scott Gallacher, director at Rowley Turton, says he believes the obstacle to securing IP is not down to the cover itself, but how it is applied. 

Gallacher says: “Most IP plans and providers, which is about 43 out of 49, actually accept dividends as income for the purposes of IP. So, this shouldn’t really be an issue in terms of getting cover. Perhaps the issue arises where you are in business with someone else and, if you do not have a different share class for each director, you might find that your dividends do not cease entirely if you are unable to work due to ill health.

“While your salary might cease – depending on the employment contract – your dividends do not necessarily cease. 

“You’d see a significant fall in your income, which is obviously an issue. You could perhaps increase your salary with no dividends but other shareholders and directors might object. Even if you do, the national insurance and tax position is worse, so your net income is lower. So, there are significant issues but not necessarily around the cover itself.”  

Read the fine print

Protection expert Alan Lakey has also weighed in on the debate and argues that when considering the most appropriate protection cover, it is important to read the small print for any grey areas, which can cause problems later on when arranging a payout. 

Lakey, who is the director of CI Expert and Highclere Financial Services, says: “It is now common for directors to enjoy a salary just below the national insurance minimum and to take income in excess of this as dividends. Both of insurer LV's IP and PSP plans will only include dividend income if it is paid 'in an established pattern'. 

"This wording is open to many interpretations. It could mean the director receiving the same dividend payment each month, quarter or year. It could be a rising income or where dividends rise mid-year and fall back – any or all of these." 

He adds: "Many directors will make dividend payments based on profitability and this generally changes year-on-year, particularly over the past two years. Other insurers do not include this stipulation, merely asking for the latest P60 and/or set of accounts. Advisers looking for certainty will need to determine how they deal with this potential problem. I prefer certainty to potential disputes, therefore I would always look away from PSP when dividends are being used.”

However, Lakey also says that advisers must evaluate each individual case separately as PSP can work well in some circumstances. 

“It is now common for directors to enjoy a salary just below the national insurance minimum and to take income in excess of this as dividends.--Alan Lakey

He says: “In other respects PSP works very well, although the £1,000 income guarantee is not as generous as many other schemes. The excellent doctor services courtesy of Square Health is included in both LV plans. The policyholder can also ensure that payments are made directly to his mortgage lender, which all advisers will know to be an extremely worthwhile option. Also, income is not affected by receipt of state benefits or sick pay from the employer.”

Covid-19 reveals income vulnerabilities

The importance of protecting income was highlighted last month by research from Halifax, which found that 37 per cent of the 2,007 Britons quizzed said they have experienced a loss in income since March 2020.

This was due to a variety of reasons including illness, facing furloughed hours, or taking time off work for caring duties.

So, it is unsurprising that 52 per cent now say that they would not be able to stretch their savings beyond six months if the main earner in their household fell critically ill.

Rose St Louis, protection director at Scottish Widows, says: “While the past year has been one of the most unpredictable any of us will ever live through, more common set-backs such as a main wage earner of a household having to take time off work due to serious illness, or the passing of a loved one, can also happen at any time.

"The issue is that many people are not protecting against the worst happening to themselves.” 

Aamina Zafar is a freelance journalist