Insurance is a financial tool. If it can minimize risk and is affordable, an insurance policy is worth looking into. If it doesn’t make sense for your particular financial situation, don’t bother wasting your money on premiums and find a better return on investment.
This is the logic that determines whether buying life insurance on essential, mission-critical employees makes sense or not. Without life insurance, the sudden death or disability of an important businessperson – an employee, manager, executive or partner – can disastrously affect a small to medium-sized company. If this person is the lifeblood of your business, such a tragedy can result in layoffs, bankruptcy, or the total loss of the business itself.
However, if a company is prepared for this loss, as all businesses should be in one way or another, the ramifications don’t have to be calamitous.
What Exactly Is a Key Person?
A key person is crucial, or “key” to the success of a business. The key person in a small business is someone who possesses valuable relationships or skills. A key businessperson could also be the sole manager in charge of running day-to-day operations or a partner whose lack of financial support would be detrimental to the company. A key man life insurance policy can help mitigate the risk of losing an important person by supplanting potential lost income.
Reasons to Consider an Employee for Key Person Coverage
Financing the hiring and training of a replacement. It is not cost-effective to hire and train high-level staff members regularly. Finding a suitable replacement in a short time is vital to keeping operations running smoothly, but key person insurance can relieve the pressure.
Paying your bills. If you own a small business, chances are your income is very closely tied to the performance of your business. With key person coverage, losing an important employee won’t cause you to default on your mortgage or credit card payments.
Caring for current shareholders. Usually the person you want covered is the company’s proprietor who has people in line to inherit the business. With key person life insurance, the company might be able to purchase the business should the owner die.
Retaining other key people. Should the company take a hit, top executives are most likely going to start looking elsewhere for employment. Losing company assets will only further weaken the company. In order to keep other critical employees, you will want to offer competitive bonuses to prevent them from being recruited by other corporations.
Meeting bank contingencies. To ensure the growth of your business, should its success be contingent upon key persons, some lenders and banks require that those people be insured.
Types of Key Person Insurance
Disability. It is more likely that a staff member will become disabled than die, but the fiscal concerns are the same.
Life Insurance. Term insurance is quite popular because it costs less than permanent coverage. This way, if an employee leaves the business for any reason, the policy can be cancelled.
Cash Value Life Insurance. Should the key person also be the business owner, a cash value life insurance policy can protect the company in case of death, as well as act as a resource to make necessary payments should the person retire.
The tax treatment involved with insurance policies is complicated and depends on a multitude of factors. The following information is merely a general idea of what’s involved and should not be taken as professional tax advice.
In general, insurance policy premiums are not tax deductible, but if the following specific IRS conditions are met, key person insurance premiums can be:
- Reimbursement of lost funds to your company
- The hiring and training of key employee replacements
- Funding the cost of a temporary hire
- Paying back debts acquired by the business because of the loss of a key person
- Not using the key person insurance for executive bonuses
Starting a business basically equates to taking a risk and can lead to uncertain times with temperamental clients and unpredictable vendors. You may not think about what could happen should you lose important employees. The good news is that the possible fiscal fallout that occurs when you lose essential people can be alleviated if you have key person insurance.