Money Matters

Key Person Insurance & How It Can Help Your Business

Transforming Tragedy into Opportunity: The Importance of Key Person Life Insurance

The small business you started with your college roommate isn’t so small anymore. With several million dollars in revenue and about a dozen employees, it’s a thriving enterprise. An independent appraiser values your 50% stake at more than $5 million.

Then tragedy strikes: your business partner dies without a will or a plan in place, transferring her share of the business to her difficult husband. He starts making plans to “improve” the company, and as a result, sales decline, and revenue dries up. You start contemplating a different future for yourself.

This unfortunate situation could have been avoided with key person life insurance. Upon your partner’s death, the insurance policy would have provided a death benefit significant enough to buy out her share, preventing her husband from interfering in the business.

What is Key Person Life Insurance?

Key person insurance is a life insurance policy a company purchases on the life of an owner, senior executive, or another individual critical to the business. The company is the beneficiary and pays the premiums. Also known as “key man insurance” or “business life insurance,” this policy ensures the business can continue operations without financial strain if a key individual passes away.

Why Key Person Insurance is Crucial

A key person is essential to a company’s success, and their absence can threaten the company’s existence. Key person insurance compensates for the loss of an essential employee’s skills or talents, ensuring business continuity.

How Does Key Person Insurance Work?

Key person insurance functions like any other life insurance, with the difference being that the company owns the policy. The insured employee must agree to it and cooperate during the application and underwriting process. If the insured dies while the policy is active, the company receives the death benefit, typically tax-free.

Coverage and Benefits

Key person insurance covers expenses associated with the death of a key employee, including:

  • Finding and training a replacement.
  • Replacing income directly generated by the deceased.
  • Covering additional expenses due to their absence.
  • Mitigating indirect losses, such as customer attrition.
  • Purchasing the individual’s interest in the company from their heirs.
  • Repaying debts contingent on the key person’s continued employment.

Types of Key Person Insurance

  1. Term Life Insurance: Affordable and remains in effect for a fixed period, usually 10-30 years.
  2. Whole Life Insurance: More expensive but permanent, building cash value over time.
  3. Variable Universal Life Insurance: Flexible, allowing investment in market-traded funds, with variable premiums.
  4. Disability Insurance: Provides long-term benefits if the insured cannot work due to a disability.

Do You Need Key Person Life Insurance?

Assess the impact of losing key employees on your business. If their loss would severely damage the company’s profitability or existence, key person insurance is essential. Consider the cost of replacing these employees and the potential revenue loss during the transition.

Frequently Asked Questions

  • Cost: Depends on policy type, term length, insured’s age, gender, health, and lifestyle. Term life is cheaper than permanent life insurance.
  • Providers: Established companies like State Farm, Allstate, and Nationwide offer key person insurance.
  • Coverage Amount: Based on replacement costs, earnings contribution, purchase price of ownership stakes, and business risk.
  • Tax Deductibility: Premiums are not tax-deductible, but the death benefit is usually tax-free. Report the policy to the IRS using Form 8925 to avoid taxation.

Conclusion

Just as we insure our cars and homes, we must protect our businesses from unexpected tragedies. Key person insurance safeguards your business against the loss of vital employees, ensuring stability and continuity in challenging times. Don’t wait for a crisis to realize its importance—plan ahead and secure your company’s future today.

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