Key person insurance for sole proprietorship

Can sole traders get key person insurance?

Yes, some policies allow sole traders to name either:

  1. Themselves as a keyman
  2. Important employees as a keyman.

What's a sole trader?

A sole trader is a business owner who makes all their own business decisions and who is solely responsible for the fate of the business, including any debts or losses incurred. Examples of a sole trader would include a small retail business such as a corner store, a home-based Internet business or a tradesperson or lawn care service (other than a franchise). While they still run their own business, they can also employ others to assist them and still be classified as a sole trader

What are the main benefits of key person insurance?

Key person insurance can provide benefits for a range of business activities affected by the loss of a key person. These can include:

  • Maintaining cash flow, which is the life blood of any business
  • Meeting loan repayments and other ongoing business expenses such as utility bills, insurance, wages etc
  • Funding a locum or temporary replacement in the absence of the key person
  • Funding the recruitment of a permanent replacement for the key person or the retraining of others within the business to take over their role

What are some of the risks associated with losing a key person in a sole proprietorship?

The key person is someone who is a valuable asset to the business because of their knowledge, experience or expertise. If they could not continue in their role, the business would be financially harmed. The repercussions of losing a key person can include the following:

  • Profitability can be adversely affected
  • Considerable time and money can be spent recruiting and training a replacement
  • Business culture and staff morale can be adversely affected
  • Goodwill and credit-worthiness may be threatened
  • Key clients and business contacts may be lost

Because a sole proprietorship is usually a small business, these repercussions can have a much greater impact than might otherwise be felt by a larger company with more resources at its disposal.

Can key person insurance cover sole proprietors?

Key person insurance is available for both:

  • The sole proprietors themselves
  • Their employees

This varies between insurers. Some policies will only provide key person cover to employees and require that sole proprietors take out other forms of cover such as personal income or business overheads insurance.

Common rules for each person who's covered.

Named keymanSole traderEmployees
How much must they contribute to the business?20% and 80% of the gross annual profitEmployee must contribute between 20% and 80% of the gross annual profit
How much of the business must they own?Sole trader must own between 20% and 80% of the businessNo requirement
Other rulesExclusions on certain occupations e.g. farmersNo more than five employees
How much is covered?How much revenue they generate the businessCan be insured for up to 150% of their remuneration package.
Who's receives the benefit?The sole traderThe sole trader

Who owns the policy in a sole proprietorship?

Whether key person insurance is taken out on behalf of the sole proprietor or their employee(s), the policy is always owned by the sole proprietor.

Before you apply: Revenue and capital purposes

As a sole trader you'll need to state (before you apply) if the policy is being used for:

  1. Revenue purposes
  2. Capital purposes

What's are some examples of keyman being used for revenue purposes?

When a key person is lost, a policy for revenue purposes can cover

  • Maintaining cash flows to meet ongoing business expenses
  • Recovering lost revenue
  • The costs of retraining/hiring

What are some examples of keyman being used for capital purposes?

When a key person is lost, a policy for capital purposes can cover

  • To maintain the capital value of the business
  • Repay any debts when a key person is lost.

Why do I need to state revenue or capital purpose?

The main reason is because of the difference in tax rules.

PurposeAre premiums tax deductibleAre payouts taxed?
Are payouts subject to capital gains tax (CGT)
  • Yes
  • Yes
  • No
  • No
  • No
  • No
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