What is The Purpose of Key Person Life Insurance for Businesses?
Written by: AEIS
What is Key Person Insurance?
It doesn't matter what type of business you're running or even the industry that you're operating in - every employee is important. They all come together to form something more powerful as a unit than they could be as individuals. Having said that, there are certain people that a business absolutely cannot afford to lose.
If a charismatic, visionary CEO or a high-earning salesperson should pass away, it wouldn't just suddenly harm the organization's financial viability–it would likely cause a permanent alteration to its reputation at the same time.
That's exactly what key person insurance, also commonly referred to as key person life insurance, is designed to prevent.
What is the Purpose of Key Person Insurance?
Key person insurance aims to safeguard an organization in the event of the death of crucial employees. For instance, not only the CEO but also vital contributors like a top salesperson are covered. Losing such a key individual unexpectedly could severely disrupt the business, making it challenging to sustain its current course and potentially leading to the business's demise if their specialized skills cannot be replaced. Key person insurance serves as a protective measure to mitigate these risks.
When Should a Business Get Key Person Insurance Policy?
When an organization heavily depends on specific, indispensable individuals, it makes sense for businesses to explore key-person insurance. In situations where your company is essentially incapacitated without specific roles being fulfilled, and the sudden absence of one or more of these key figures could jeopardize operations, having a key-person insurance policy becomes crucial for protection.
How Much Key Person Insurance Coverage to Buy
As is true with most types of business insurance, there is no "one size fits all" answer to this question. As a rule of thumb, consider both the immediate and long-term financial impact should a key individual suddenly pass away. How much financial damage would occur, or how much would you need to stay afloat? You can then work your way backward to the amount of coverage you need. Another option is to purchase 5 to 10 times the key employee’s salary.
Note that included in your coverage should also be enough money to recruit and replace the key person’s position.
Policy Types to Consider
Not unlike other types of insurance, there are a few different key-person policy types that you'll want to consider. Each has its own unique advantages, which is why knowing as much about them as possible is the key to making the best decision for your company.
Term Life Insurance
As the name implies, term life insurance offers temporary coverage that lasts for a specific period of time. If you have a key employee who also happens to be relatively young and healthy, this would be the more cost-effective route to go. Terms tend to last between ten and 30 years. Although you will likely be able to get another policy when that term ends, you'll have to pay more because the key employee will be significantly older.
Permanent Life Insurance
Permanent life insurance would be appropriate in a situation where the key person you are trying to cover is one of the founders of the company, for example. Whereas a top salesperson might eventually leave to go work for someone else, the chances are high that the founder is there for the duration. In that case, this type of policy would make sense.
- Whole Life Insurance. This is a type of key person life insurance policy that has a guaranteed premium that stays flat for the duration of the policy. Whole-life policies also accumulate cash value in a tax-advantaged way with a predictable, fixed interest rate.
- Universal Life Insurance. This is another type of tax-advantaged policy, but it offers more flexibility in that payments can vary within a specific range. Depending on who you choose to go with, you may even be able to invest your policy - although this does expose you to market volatility in a way that other types of policies do not.
Is Key Person Insurance Tax Deductible?
Unfortunately, no. According to the IRS, unlike other types of insurance premiums that you may pay that you can deduct on your taxes, premiums for key person insurance are not a deductible expense on federal income taxes.
However, there are still certain tax implications to be aware of. The cash value in a permanent policy is tax-deferred. This means that the policy can compound more interest. A small business can borrow against the value of a permanent policy without it being considered a "taxable event." Talk to a financial professional before you do so.
AEIS Support for Your Insurance Needs
At AEIS, key person insurance is just one example of the solutions we offer to help your business thrive. We understand that especially when it comes to things like health insurance, the landscape is getting more complicated all the time. Making sure that you have the right policies in place to protect everything you've worked so hard to build can often feel like an uphill battle - largely because it is.
That's why we want to step in and take care of everything on your behalf.
Through our business administration solutions, we'll learn everything we need to know about your organization in intimate detail. That way, we can make sure you always have the right coverage for you and your people - allowing you to rest easy knowing that complicated topics like key person life insurance are not things you have to spend time worrying about again.
If you'd like to find out more information about the purpose of key person life insurance, or if you have additional questions about protecting your business that you'd like to go over with someone in more detail, please don't delay -
contact the AEIS team today.
We're here to help.
Schedule a free phone consultation today.
P: 650.348.6234
E: team@aeisadvisors.com
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