Income Protection and Tax

Insurance payouts are not usually taxable in the UK. Income protection insurance in particular is designed with this in mind. If you have to stop working because of illness or injury, your policy won’t pay you the same as you earn. Instead, it will be a proportion of your income - Eleos offers up to 65%. This is because it’s intended to make up for the income you’ve lost, after your tax and national insurance contributions have been deducted. The maximum payout is calculated to be roughly the same as your take-home pay.

Tax-free cover

You won't pay tax on your replacement income with an Eleos policy

If you take out your own income protection insurance policy the rules on tax are straightforward.

Premiums

Provided the premiums for your policy are paid by you from a personal bank account, they’re not taxed.

Benefits

When you make a claim on your insurance policy and your insurer approves your claim, they’ll pay you your monthly benefit directly into your bank account. Because you’ve paid the premiums out of your salary after paying tax, these benefits are not taxable.

The rules on group income protection can be different, because your insurance is provided by your employer rather than you.

Premiums

Some employers provide group income protection schemes for which they pay the premiums. Since those premiums are intended to benefit the employee, HMRC is entitled to treat the premiums as taxable benefits, like any other perk such as a company car. This means you could pay tax on those premiums.

You might have agreed to a pay cut, on the understanding that your place in a group income protection scheme will be paid out of the difference. Even if this is the case, the premiums may still be treated as a taxable benefit.

However, if you pay into a group scheme out of your taxed salary you won’t pay tax on the premiums.

This is the position since HMRC issued guidance in 2023, to clear up earlier confusion. Whether they’ve succeeded is a matter of opinion.

Benefits

Money that you receive as sickness or disability pay from a group income protection scheme is taxable in the same way as earnings.

There are no tax implications if you arrange and fund your own income protection insurance policy. However, group income protection schemes are much more complicated. In some cases it’s not at all clear whether you’ll be expected to pay tax on either the premiums or the benefits. As you can see, if you’re planning to join a group scheme, there are a lot of questions to be answered first.