Key Person Insurance
When taking inventory of assets, companies include buildings, computer equipment,
and inventory. In other words, companies value their tangible items – items that
can be replaced if lost in a fire or some other type of disaster. One asset that
is often overlooked is the human capital of the company. Each business, regardless
of its size, has an individual or group of individuals who contribute to its success
and without them the business would have a difficult time surviving. Like tangible
assets, insurance protection can be purchased for those key employees.
What is Key Person Insurance?
You can protect your business from the loss of a key person by implementing a key
person insurance plan in which your company purchases and owns a life insurance
policy on the life of a key employee. The life insurance policy will provide the
company the liquidity needed to keep the business running in the event of the key
employee’s premature death. The plan provides the cash needed to hire a qualified
replacement and/or to purchase the additional human capital or assets necessary
to keep the business operating. The plan may also help to replace lost profits as
a result of the loss.
While the main purpose of key person insurance is to provide a death benefit to
the business in the event of an unexpected or sudden death of an essential employee,
it can also be used as a way to provide the key person with retirement benefits.
How Does Key Person Insurance Work?
The business buys a life insurance policy on the life of the key executive. The
business is the owner and the beneficiary of the policy. The business pays the entire
premium and will receive the entire death benefit. The executive does not have any
interest in the policy, nor does his family receive any benefit from it when death
occurs.
Why Life Insurance?
Life insurance can be used by the business to replace the key employee. The life
insurance provides the company with the funds to:
- Keep the business running
- Assure creditors of a smooth transition
- Assure customers the business will run as usual
- Cover the expense of finding and training a suitable replacement
- Provide the company with a valuable asset on the company’s balance sheet that can
be used for unexpected corporate expenses
How to Determine Who Is a Key Person
Some people may argue that all employees are essential to running the company, from
the CEO down to the maintenance people, and that they should all have key person
insurance policies. However, reality dictates that some individuals are more important
to the survival of the operation than others. Key employees can be the business
owners, successful sales reps, or individuals whose daily contributions are key
to the success of the business. To determine a person’s value to the company, several
factors should be taken into consideration. Some of these factors are:
Business Owners
- Ability to obtain financial assistance: If something happens would the business
still be able to obtain financial backing?
- Knowledge of the products and operations: Does this person have special knowledge
about the operations and products?
- Competition: Would rival companies have an advantage if this person were
gone?
- Customer Relations: Is this person the relationship maker?
Non-Business Owners
- Sales Ability: Will you be able to meet sales goals without this person?
- Knowledge of the products and operations: Does this person understand the
market and product so well that creativity just happens?
- Important Contacts: Does this person have the contacts needed to get results
in a crisis situation?
How to Determine the Right Amount of Key Person Insurance Coverage
A typical rule of thumb for deciding the amount of life insurance coverage is five
to ten times annual compensation. In addition to the items listed previously, there
are other things that should be taken into consideration such as:
- How much will it cost to replace this person?
- How much is the person worth to the bottom line?
- If something happens today, what would it cost the business?
- How much of the company’s actual loss are you willing to insure?
Benefits of Key Person Insurance
The purchase of key person insurance benefits both the business and the executive.
The business benefits from having a source of income to cover the expenses that
occur with the loss of a key person. It can also access the potential cash value
of the life insurance policy for cash flow, retirement benefits or other unexpected
expenses.
The executive benefits from the knowledge that he or she is essential to the business
operations, and the key person plan may be used to fund the executive’s supplemental
retirement income through policy loans and withdrawals.
Tax Implications of Key Person Life Insurance
In most instances, a key person life insurance arrangement benefits the corporation.
The only involvement the executive has is being the insured. The business receives
a tax deduction for the life insurance premiums and will receive the death benefit
proceeds free from income taxes upon the death of the executive.
Finally, Key person life insurance is an important way for a business to protect
itself against the loss of key employees, partners, or owners. Key person life insurance
is simple to set up and easy to implement and should be considered by a small business
whose day-to-day and long-term performance may be in jeopardy if something happens
to one of its vital employees.
For further information and to learn more about your options Contact us now.
 |