71% of organizations claimed they were very dependent on one or two key employees, yet only 22% had key-person life insurance.*
Key Person Insurance.
Businesses regularly insure their tangible, physical assets like buildings, inventory, and equipment, but often overlook their most important asset – their people. Each business, regardless of its size, has an individual or group of individuals who contribute to its success. The unexpected death, disability or illness sustained by one of these “key” people can threaten the success of the company. A key person insurance strategy helps the business insure against financial impact if a key employee is no longer able to contribute.
Here’s how it Works.
The business owns, pays for, and is the beneficiary of a life insurance policy on the life of the key manager. The business can use the income tax-free death benefit to replace lost profits, recruit and/ or retain qualified replacements, or protect the company’s credit position. The policy may be designed where the employee receives no interest in the policy, or a portion could be allocated to the employees family. Once the employee retires, the company can retain the policy, use the policy to provide the employee with supplemental retirement income, or transfer the policy to the employee for his/her own personal insurance needs as a bonus to the employee.
In the example above, Mike would be subject to taxes based on the economic benefit.
Who is a “Key Person?
A key person is anyone in a business whose loss would be significant to the company. This person can be either a business owner or a non-owner employee. Employees who are “key” to the success of a business include individuals with unique leadership ability and expertise; specialized technical/creative skill or knowledge special connections, contacts or influence; or other qualities that set them apart.
How to Determine the Value of a Key Employee?
There is no set formula to precisely determine the value of a key employee; rather several factors should be considered that can help to approximate a key person’s worth to a company. The approach taken by most carriers’ underwriters, is to look at a multiple of a key employee’s total compensation to determine what may be an appropriate amount of coverage. Compensation can include salary, bonuses, commissions, and other types of employee benefits . Increased coverage may also be justified based on a percentage of debt that has been personally guaranteed by the key employee.
Term Insurance or Permanent Insurance?
Term insurance is often purchased for key person coverage because the need is for a specified period of time and to minimize cost. Permanent insurance is used when there is a need to provide protection to both the company and insured or when the business owner wants to build policy cash value for supplemental income needs.
For employee retirement benefits and business insurance planning,
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Please note, we do not offer legal or tax advice. For educational purposes only.
* Insurance Information Institute