Director's loan account protection

Many directors put their own money into the business: to start it, to fund growth or to see it through a quiet spell. That money is often recorded as a loan from the director, so the company owes it back.

While the director is alive, repayment can be taken at a pace that suits the business. After their death, the loan normally passes to their estate, and the executors may want it repaid so they can settle the estate or provide for the family. Finding that money at short notice could affect the company's cash flow, its borrowing or its ability to carry on as normal.

A common approach is for the company to take out and pay for a life insurance policy on the director, with the company as the owner and beneficiary. If the director dies during the term, the payout goes to the company, which uses it to repay the loan to the estate.

Critical illness cover can sometimes be added, so there is money to repay the director if they become seriously ill and want their funds back. It pays only when the illness meets the policy's definition, and definitions vary between insurers.

Other arrangements are possible, and the right one depends on the company's structure and the director's plans. If the company also has bank borrowing, our guide to business loan protection explains how that debt can be covered.

The main factors are:

• •The current balance on the director's loan account, taken from the company's accounts
• •Whether the director plans to lend more, or draw the loan down over time
• •How long the loan is likely to remain outstanding, which sets the term
• •The director's age, health, smoking status and occupation
• •Whether critical illness cover is included, which increases the premium

Loan balances rarely stay still. Reviewing the cover against the balance at each year end, and whenever the director puts in or takes out a large sum, helps avoid a shortfall or paying for cover the company no longer needs.

Cover that repays a director's loan is usually viewed differently from cover that replaces lost profit, and its tax treatment depends on the circumstances and applicable conditions. The same is true of how the payout is treated when the company receives it. The company's accountant should confirm the position before the policy is set up, and can also help confirm the loan balance and how it will be repaid.

This cover is separate from protecting the director's shares, which is the role of shareholder protection, and from protecting the director's family, where relevant life cover may be worth considering.

Ask your accountant for the current balance on your director's loan account and how you expect it to change. We can then recommend how the cover should be owned and how much is needed, compare policies from our panel on benefits and terms as well as price, and set a date to review it alongside the company's accounts.