Severn Accounting
Tax & Accounting

Key person insurance – when can you claim a deduction

By Ali Jaw ·

Key person insurance – also known as key employee insurance – can be a sensible business protection strategy. But from a tax perspective, the rules around when you can claim a deduction are surprisingly restrictive. We’re breaking down the HMRC guidance to help you understand exactly where you stand.

What is key person insurance?

Key person insurance is a life insurance policy taken out on a member of staff whose absence would significantly impact your business – perhaps your sales director, technical expert, or managing director. The business is the policy owner and beneficiary, meaning if that person dies or becomes seriously ill, the payout goes to the company to cover costs, recruit replacement staff, or weather the financial disruption.

It’s a genuinely valuable risk management tool. The problem is that HMRC doesn’t automatically allow you to claim the insurance premiums as a business expense for tax relief purposes.

The HMRC position on deductibility

Under general corporation tax principles, a business expense is only deductible if it’s “wholly and exclusively” for business purposes (per the Income Tax Act 2007, section 54 for sole traders and partnerships, or corporation tax equivalent rules for companies).

HMRC’s stance on key person insurance premiums is narrow: you cannot claim a deduction for the premiums themselves. The reason is conceptual – the policy ultimately protects the business’s financial interests rather than being an expense incurred in earning income. The premiums are treated as a personal benefit arrangement, even though the business pays them.

This applies regardless of whether your business is a sole trader, partnership, or limited company. The restriction is consistent across all entity types.

When the payout itself gets tax relief

Here’s where it becomes important to distinguish between premiums and proceeds. Whilst you can’t deduct the premiums, the insurance payout is not taxable income when received. This is because it’s treated as compensation for loss rather than revenue income.

However – and this is crucial – you cannot claim a deduction for any business losses you incur whilst waiting for the payout or whilst the replacement period occurs. The policy is meant to mitigate those losses, not to create a separate tax relief opportunity.

If the proceeds are invested and generate interest or dividends, that investment income will be taxable in the usual way.

Salary continuation insurance – a different angle

You may also encounter salary continuation insurance (or income protection insurance), where the policy covers an employee’s salary if they’re unable to work due to illness or injury. The tax treatment here is different again.

If your business pays the premium on a salary continuation policy for an employee:

  • The premium itself is not deductible as a business expense
  • If the employee receives a benefit (the continuation of salary payments), that benefit may be treated as taxable income to the employee
  • You may need to operate PAYE on the benefit

Some employers structure this differently – by allowing employees to pay premiums from their own salary (via payroll deduction) – which can be more tax-efficient, but specialist advice is needed here depending on the specific arrangement.

Best practice for key person insurance

Given the restrictions, consider key person insurance as a cash preservation and business continuity tool rather than a tax-efficient deduction. You might:

  • Budget for the premiums from retained profits or as a business cost that doesn’t generate tax relief
  • Ensure the payout amount is realistic – it should cover recruitment, training, lost earnings, and loan repayment costs if applicable
  • Review your policy regularly alongside your business plan, especially if key roles change
  • Keep clear records of the policy’s business purpose for HMRC audit purposes

Conclusion

Key person insurance is not a tax-deductible expense under UK tax law, even though it’s a legitimate business protection mechanism. The premiums don’t reduce your taxable profit, but importantly, the payout is not taxable income either. What you do with that payout – and how quickly you can stabilise the business – is where the true value lies.

If you’re considering key person insurance or already have policies in place, it’s worth reviewing the overall structure with your accountant to ensure you’re optimising your tax position across all related arrangements. Similarly, if you’re weighing up salary continuation or income protection insurance, the tax and employment law implications warrant proper consideration beforehand.

For tailored advice, contact Severn Accounting — we’re here to help.