Key Person Insurance: Cash, When It’s Needed Most
If the ongoing success of your business depends on one or more key individuals, insurance may prove helpful. The death or disability of a key person—such as an owner or manager who brings in customers—can result in difficult times for your business. Even in the midst of such troubling circumstances, there will be no grace period: Cash flow must continue, and customers may need reassurance that your goods and services will continue to be available. The dual responsibilities of buying out the key person’s shares or interest in the company and finding and training a new executive may also prove challenging.
Key person insurance—term or permanent life insurance that makes the business the owner, premium payer, and beneficiary of the policy—may help provide the funds needed to accomplish tasks that will require immediate attention, such as dealing with creditors who are concerned about the repayment of outstanding loans and debts during a time of transition.
If you have investors, they, like creditors, may be worried if your company loses an important executive. In fact, they may require that key people be insured as part of a comprehensive business continuation plan for your company.
Purchasing the right amount of insurance may depend on how much the key person contributes to the company’s revenue flow. If that figure is difficult to determine, another starting point could be his or her annual salary.
The “Muscle” Behind Buy-Sell
If the primary purpose of the policy is to fund a buy-sell agreement, as opposed to meeting ongoing expenses, then the amount of insurance will be equal to the portion of the business’s total value as stated in the agreement. Life insurance provides muscle to the buy-sell agreement. Without such a resource, taking on personal debt may be the only option to buy out the key person’s survivors.
If the insurance is purchased to accomplish both purposes—fund the buy-sell agreement and pay current operating expenses—the amount of insurance needed may be considerably higher.
A Policy with “Legs”
Attaching a rider to a whole life policy will allow your company to change the insured’s name if the key person leaves the company or retires. If it’s time for retirement, the policy can be kept in force by the company and offered to the key person as part of a retirement package. There could, however, be tax consequences. Generally, insurance premiums are nontaxable to the insured if the policy is purchased for the benefit of the business and the insured has no interest in the policy. However, if any proceeds from the policy are paid to the employee or his or her beneficiary, they could be considered taxable income.
Although most business executives will typically weigh the value of term versus permanent life policies in determining their key person insurance needs, another protective option for businesses is disability income insurance (DI). Key person disability income insurance will pay a monthly benefit that’s determined by the key employee’s pre-disability earned income. The monthly DI benefit can then be used for the same business purposes as the term or permanent life policies, such as providing revenue to hire and train a replacement or to strengthen the company’s cash flow.
No matter what the insurance vehicle, key person insurance for a valued business partner, executive, or employee may be an ideal way to realistically assess and acknowledge the value of his or her contribution to the success of your business.
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