Contracting is growing rapidly and creating a life insurance and income protection cover ‘time bomb’ of too many unprotected and uninsured new contractors. This rise in contractor numbers is structural, and not due to recession-driven underemployment, so the problem will only get worse.
“Most contractors leave full-time employment to become contractors and many took for granted benefits such as death in service that would provide the family with a lump sum if the worst happened,” explains Mark McBurney, life and income protection insurance expert at CMME.
“The latest ‘Kingston Report’ from the Association of Independent Professionals and the Self-Employed (IPSE) shows contractor numbers have grown by 35.15% since 2008, and by 8.7% alone over the last year.
“This is great news for contracting, but too many of these ‘newbies’ forget they have left the comfort blanket of employment, and the benefits that come with it, behind. Others wrongly assume that any private life insurance and income protection cover they have is sufficient.”
What life cover and protection do new contractors have?
According to McBurney, any death in service benefits cease as soon as an individual leaves full-time employment and many contractors do not give any thought to putting protection in place to ensure their family is financially secure should they die prematurely.
“Contracting requires a mindset change,” he says. “Alongside the freedoms and elevated income that contractors enjoy comes the responsibility of having to take greater control of their financial destiny.
“This is a frequent conversation I have with new contractors who are adjusting to the new realities of their new lifestyle. I find that the vast majority of contractors really enjoy taking control because they can tailor protection solutions to their own needs.”
As well as losing death in service, new contractors may find that any existing personal life insurance or income protection is inadequate for their new lifestyle needs, and in some cases simply won’t pay out as expected.
“As soon as they know they’ll be leaving employment to go contracting,” adds McBurney, “all new contractors should meet for a review with a specialist financial adviser who really understands contractors and freelancers. High-street financial advisers often incorrectly pigeonhole contractors with the self-employed, and they are not the same.”
Life insurance options for new contractors
In McBurney’s experience, most contractors look to pay off any outstanding debts, such as a mortgage, and to provide a lump sum or income to that their family is financially secure in the event of their untimely death. So, ideally, a new contractor should be considering two main options:
- Relevant life cover, which limited company contractors can put into place to replace the death in service benefit they used to have when employed
- Personal life cover, suitable for both limited company and umbrella company contractors, this can pay out a lump sum and/or be structured around a mortgage.
“The overriding benefit of the relevant life cover is that it replaces death in service, and is also tax efficient as the limited company pays the premiums. Personal life cover can also be cost effective as it can be tied into a mortgage so premiums are often lower from the outset.”
When choosing a policy and the amount, contractors need to consider several factors, including the purpose of the policy and what the cash will be used for, and the contractor’s long-term objectives.
McBurney explains: “A contractor who is only planning to contract for a few years and then return to employment may not wish to consider relevant life cover through their company, although it is possible to convert these company policies into personal policies.”
Choosing family income benefits over a lump sum
Relevant and personal life cover will typically pay a lump sum on the contractor’s death. But that’s not the only option. McBurney explains: “Family income benefits can pay a monthly income, which for some contractor’s families may offer a better solution.
“This insurance can be index linked so that the income remains at a meaningful level. If you consider that the value of money halves roughly every seven years, a £500,000 payout now is not going to be worth as much in the future. Family income benefits is one way around this.”
Not all contractors have dependents, or dependents who need financial support. Plus many contractors have significant cash savings and assets. So McBurney urges contractors to engage with a financial adviser who can tailor a protection solution specifically for them.
Income protection policies may not pay out
McBurney highlights that another common issue arising with new contractors is the suitability of their old income protection policy: “A lot of contractors who have had had high-paid jobs have very prudently invested in an income protection policy that will provide an income if they lose their job or are unable to work.
“In most cases, these policies are designed for employees with relatively stable employment income. So, if the contractor loses their job and makes a claim, they have several years of P60s to demonstrate their income.
“Income protection policies do take into account both salaries and dividend income, but a contractor’s income can fluctuate, or they may be sharing the company’s income with a spouse or civil partner for tax reasons.”
Why old income protection policies won’t work for contractors
McBurney gives an example: “Income protection insurance providers don’t want you to be better off out of work than in work, so typically 50-60% of your income is covered. Let’s say a contractor was earning £80,000 a year before they became a contractor and their policy covered 60% of their income, or £48,000.
“The contractor starts working via a limited company and, because they are running the business tax efficiently and not taking all their fees so their income was £43,000. The contractor thinks they have cover in place for a set amount.
“When a claim is made, most providers assess income on salary and dividends. They will look at the contractor’s earnings and decide that the income to be assessed is £43,000, so will only pay 60% of £43,000 and not £80,000. Bear in mind the provider will happily continue to take the premiums for the £80,000 of cover, even though they may not pay out on that sum.”
Contractors with income protection should get their policy reviewed and, if necessary, change to another provider.
McBurney concludes: “This example highlights the time bomb ticking away in the financial affairs of so many of the new contractors who have started work since 2008.
As soon as they start looking for their first contract, new contractors should contact a financial adviser to review their life insurance and other protection policies so that they and their families can continue to enjoy financial security even if the worst happens.”
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