Key Man Insurance or Key Person Insurance Explained

Key Man Insurance is Important to Protect Your Important Employees

Key man insurance, also called key person insurance or key employee insurance, is a type of life insurance coverage that protects a company in case of the untimely death or disability of a top salesperson, executive or business owner. Key man insurance provides peace of mind to business owners and shareholders alike knowing that the business can continue operations without major disruption in the event of the loss of a key employee. If death or disability strikes your company, key person insurance may be the difference between the company’s demise and its ultimate success.

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Provides a lump sum payment if you become totally and permanently disabled and are unable to return to work.
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What is Key man Insurance?

A lot of people have the wrong notion that key man insurance is similar to life insurance or disability insurance. Although life insurance is one of the important features of a good key man insurance policy, so is disability insurance. This is because the risk of disability due to an illness or injury is as real as the risk of death. Moreover, as your employees grow older, so do their risks of disability or death. Therefore, to provide ample protection, it is advisable for you as a business owner to get key man insurance for your most valued and best performing employees.

Key man Insurance is basically designed to offer your business the following benefits:

  • Fund the training of the replacement employee
  • Settle dues and outstanding loans the company might have as it makes new adjustments
  • Boosts the credit position of your company
  • Secures loans that would help your business thrive and expand
  • Help transition company ownership to the next leaders
  • Purchase stock from the estate of the deceased owner
  • Offer salary continuation to the beneficiaries of the insured
  • Fund executive compensation loans.

The Benefits of Key Man Insurance

It has been said that behind the success of every man is a woman. Regardless of who is behind whom, the saying simply means that none of us can rise to great heights of success on our own, and your business is no different. Behind every successful business is a group of individuals who work tirelessly together as a team. But the question arises again what would happen if one of the person in your team will be forced to stop because of an injury or illness. Would his short-term or long-term absence greatly affect your company’s core operation or sales?

Whether your business is considered small-scale, medium-scale, or large, it is beneficial for you to purchase key man insurance. Why? If you look closely, there are thousands, or even millions of companies who operate with mostly four to ten personnel. With such a number of people running the day-to-day affairs of your business, it is easy to see how the absence or loss of one can greatly affect the profit of your company.

The solution for this is to obtain key man insurance. Having this type of insurance for your company helps stabilise it in times of loss because of an illness or injury. It lessens the impact created by the loss of one of your major or key people. Other benefits of a key man insurance policy are:

  • A Great Back-up Plan: It covers the cost of replacing the losses that your business will incur in the event of indefinite or long-term illness, injury, absence, or death of the key person or people in your company.
  • Covers Hiring or Replacement: In case you lost the key person in your company, the key man insurance policy will help cover the cost of replacing or hiring another person to replace him.
  • Financial Coverage: One of or the most important benefit you can get is the cover for any financial loss incurred b the loss of a key personnel. Any down trend or loss in sales and profit as a result of losing that key personnel will be compensated. Knowing that your business is covered and protected against such loss can bring security and peace of mind to any business owner.
  • Power of Choice: Being able to choose is one of the best things in life. With key man insurance policy you have a choice which employee you want to insure. You also have the choice to retain the best and let go of the unnecessary burdens.
  • Retains Employees: Giving your top employees enough cover can boost their morale. It sends them the signal that you care for their well-being as an employer. You also avoid losing your best people to competition. Aside from this, you just don’t protect the most important people, but your business as well.
  • Tax Deductibles: Aside from being very obtainable because you don’t need to comply with special filings, key man insurance and disability policies are usually received by the company as tax-free.
  • Used as compensation funds: Key man life insurance can also be used by the business to fund the compensation plans for key executives. These policies can be long-term, which in turn can be used to build equities that are accessible for use when the need arises.

Key Person Insurance Premiums Tax-Deductibility

As is the case with most other types of insurance policies, the premiums that you pay for key person insurance may or may not be tax deductible. Whether or not you will get the benefit of tax deductible premiums will depend on the purpose for which the key person insurance was purchased. Most businesses buy key person insurance for two main reasons, which are:

  • For revenue purposes. If a key person insurance is purchased to cover activities or situations that have direct impacts on the revenue-generating capacity of a business, then the premiums paid will be tax-deductible. For example, if the loss of a key person will result in a fall in sales, or cause business profits to decrease significantly, then the purpose of the keyman insurance is coverage for revenue and therefore, the premiums are tax-deductible.Similarly, if the loss of a key person results in bad debts for the business, then the insurance bought to compensate for such losses will get the benefit of tax-deductible premiums. Other examples of revenue purposes for key person insurance that result in tax deductibility of premiums are covering costs incurred to hire a replacement for the key person, costs incurred in training such replacements, and hiring temporary staff to fill in for the key person till they return to work.If the key person insurance is bought for any of these purposes, then the premiums paid for the insurance will be tax-deductible. It is important to note that even though the premiums are tax-deductible, the actual proceeds from the insurance will be considered as assessable income for the business. Also, while determining the tax deductibility of key person insurance, the taxation office does not simply look at the stated reasons for which the insurance was purchased, but they also look at where the proceeds of the insurance were actually used.
  • For capital purposes. Many businesses purchase key person insurance for capital purposes, which can include:
    • Repayment of loans taken from the key person
    • Maintenance of the goodwill of the business that may have suffered due to the loss of a key person
    • Repayment other business debts that are called in because the stability of the business is in question after losing a key person
    • Replacement of various lines of credit that may have been lost along with the loss of a key person.

    If the key person insurance is purchased for any of the reasons above, then the premiums paid are not tax-deductible. However, the proceeds of the insurance policy (whenever they are received), will not be considered as assessable income for the company. The proceeds are not assessable income as long as the key person insurance was in the form of a term insurance policy. However, if the key person insurance is in the form of Trauma insurance or Total and Permanent Disability insurance, then the insurance benefits that are received directly by the business will be subject to Capital Gains Tax (CGT).

As is evident from the above, there could be considerable tax benefits of key person insurance that businesses stand to gain from. However, since this is an area of immense complexity, it is advisable to consult a tax professional who will be able to advise you on the best options for your business.

Insuring employees is a sure fire method to take your company away from possible disasters in the future. It gives peace of mind knowing that your company will still continue despite setbacks and losses.

Purpose and conditionsPremiums tax deductible?Benefits taxed?Insurance benefits impacted by capital gains tax?
Revenue Purposes
  • Yes
  • Yes
  • No
Capital purposes
  • No
  • No
  • No
  • Only for business taxes
  • Only for business taxes
  • Benefits are subject to capital gains tax if the recipient is not business, and is not a relative of the key person

William Eve

Will is a personal finance writer for specialising in content on insurance. While he cannot give personal advice to clients, Will enjoys explaining the intricacies of different types of protective cover to help individuals and businesses find affordable cover that won't leave them underinsured.

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