Tim has been a client of ours for a number of years. He is in his late thirties, and owns and runs a small but very successful computer consultancy company, employing five people. Our previous meetings had focused on starting his retirement planning and building a portfolio of investments.
At a recent review meeting, Tim explained that the opportunity had arisen for his company to purchase a similar local computer company. He had made preliminary inquiries with his bank, which had indicated that it would be willing to lend his company the funds required. To protect its position, however, in addition to a personal guarantee, it would require a loan protection policy to be effected. Tim was not clear what the bank meant.
What the bank requires is a life assurance policy to be put in place on Tim's life. In the event of his premature death the funds would be available to repay the outstanding loan. This is is often required when the lender wishes to strengthen its own security, or it is lending to a new or small company.
The benefits of having such an arrangement are that should Tim die before the loan is repaid, his company would have the funds avail able to clear the loan, helping it to continue trading. The bank will not be forced to call on Tim's personal guarantee of the loan to make up any shortfall - thereby enabling his estate to be left intact for the beneficiaries of his will.
Such policies are appropriate to all types of business structure, be they sole traders, partnerships or companies, where there are loans from a financial institution. Such loans may be for items of capital expenditure (as in Tim's case) or simply to cover the agreed overdraft facility.
"Is it going to be expensive?" Tim asked. I explained that the cost of suitable cover depended upon a number of factors, primarily governed by the amount and repayment period of the loan itself. Tim indicated that he was still finalising his negotiations for the purchase and anticipated that the company would need to borrow pounds 75,000 which, if all went to plan, would be repaid after 15 years.
There are a number of different types of life assurance policy that Tim could use to cover this risk. All, however, provide a lump sum on the death of the life assured, in exchange for a regular premium payment. I explained the option of a term assurance policy. This is one of the simplest and cheapest means of obtaining life cover. It provides a known sum on the death of the person whose life is assured, within the term of the policy. The sum assured and the term are selected at the outset. There is no investment element, so the cost of obtaining the life cover is relatively low.
Premium rates on such policies have fallen in recent years. This is due to a combination of factors, including the competitiveness of the market, as well as an over-estimate in the Eighties of the impact of Aids on the mortality rate. Given that such products are mainly selected on the basis of price, it is worth contacting an independent financial adviser to compare the premium rates of a number of different providers. In Tim's case, the premium for a suitable term assurance policy ranged from pounds 14 to pounds 19.85 per month.
The tax position of the policy premiums and benefits depend upon a number of factors, including whether the policy is effected by the individual, and whether it is on their own life or by the company itself. If the policy were to be effected by the company, we would advise Tim on how to approach his inspector of taxes, for clarification concerning the taxation of the premiums and the policy proceeds. Normally, if the purpose of the policy is to repay a debt, premiums cannot be offset against corporation tax. As a general rule, if tax relief is not allowable on premiums, the proceeds are not taxable.
Tim contacted me about a month after our meeting. His negotiations for the purchase of the second company had been successfully completed and the borrowings from the bank had been secured. The cover he required was therefore put into force. For the modest monthly premium of pounds 14, the financial security of his company, as well as its increased workforce, are protected in the event of Tim's premature death. The bank has the security it requires in order to make the loan. Finally, Tim's estate is protected from having to make good any shortfall to the bank as a result of his personal guarantee on the loan.
James Bruce is senior financial planner at Corporate and Personal Planning, a fee-based firm of independent financial advisers. The address is Highwoods Square, Highwoods, Colchester, Essex C04 4BB (01206 853888)Reuse content