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Key Person Life Insurance

Key Person Life Insurance

| October 16, 2020
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Key Person Insurance is a life insurance policy that a company purchases on the life of a key executive. The company is the beneficiary of the plan and pays the insurance policy premiums. This type of life insurance is also known as "key man insurance," "key woman insurance" or "business life insurance."

If the sudden loss of a key executive would have a large negative effect on the company's operations, Key Person Insurance coverage provides the assurance of business continuity. The payout provided from the death benefit covering the Key Person essentially buys the company time to find a new person, or to implement other strategies to save the business.

The primary question that needs to be answered is whether or not the Key Person's absence would jeopardize the continued operations of the company. If this is the case, Key Person Insurance is definitely a priority. In a small business, the Key Person is usually the owner, the founders or perhaps a key employee or two.

Key Person Life Insurance differs from most other life insurance policies because the business is both the owner and the beneficiary of the policy. The insured essentially has no rights or active participation in the policy. However, the business is legally required to notify the insured of its intent to purchase coverage, provide them with details of the policy, and obtain their written permission before purchasing it. This can be accomplished by using an Employer Owned Life Insurance Acknowledgement and Consent Form, which can be obtained from the insurance carrier.

Key Person Life Insurance may be required if your company wants to obtain additional capital via a loan or investment. The SBA, as well as many banks, may often require Key Person Life Insurance as part of their lending criteria. Likewise, if your business is looking for investors, they may want assurance that the loss of certain employees would not cause the company financial distress.

Generally there are three considerations in arriving at the amount of insurance needed: (1) multiple of compensation, (2) percentage of revenue or profit, and (3) cost to replace. As to the first consideration, the employee’s compensation is multiplied by the number of years the company expects it might need to replace the Key Person or to recover from their death. In measuring revenue or profit, the amount attributable to the insured employee is multiplied by the number of years it may take to replace him or her. Finally, the cost to replace the key person is a sum of the expense to find, hire and train a new employee as a replacement for the insured. This approximation should also include an estimate of business lost during the recruiting period, and possibly after the replacement is in place.

When it comes to tax consequences, generally the cost of Key Person Life Insurance is not tax deductible and premiums must be paid with after-tax dollars. Your company can only deduct Key Person Insurance premiums if they’re considered to be part of the employee’s taxable income, in which case the employee is the beneficiary.

Upon the passing of the Key Person with the company as the beneficiary the death benefit is paid tax free. There is an exception for a C Corporation for which the death benefit would be included in the calculation of the alternative minimum tax (AMT) due. For a more complete and detail tax consideration, consult with your tax professional.

In summary, Key Person Life Insurance is an essential tool to reduce the risk of business disruption by paying a death benefit if a Key Person, that is critical to the business operations, passes away. Such insurance is needed if the Key Person’s death would be devastating to the future of the company. For quotations and analysis without charge or obligations, let our network of professionals review your particular circumstances.

 

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