Key man insurance is life insurance that a company buys to cover employees whose contribution to the organization is critical to its continued success. The company pays the premiums on the policy and is the policy beneficiary. If the insured individual dies, the company can use the payout to search for and hire a replacement, pay off debt, defray business losses or even buy the company from the estate of the deceased. In some cases, the proceeds may also help replace lost income and pay final expenses for the family of the person who died.
What Kind of Business Needs Key Man Insurance?
Key man insurance is especially important for small and medium-sized businesses whose operations depend on a few people to survive. If one person in a partnership dies, for example, the remaining partner might not be able to keep the business going alone. Or they might need cash to buy the partner’s share of the business from the family of the deceased.
Who Should be Covered Under a Key Man Insurance Policy?
Typically, key man insurance is reserved for “mission critical” employees, such as proprietors, partners, and those who possess essential relationships or skills. But that doesn’t mean that “key” employees are always top level executives or partners in the firm. Consider what would happen, for example, if a successful restaurant suddenly lost its top chef. Or a real estate business lost its No. 1 realtor and sales plummeted by 50 percent.
Bottom line: a key person is any employee whose prolonged or permanent absence would send your company into a tailspin.
What Kind of Key Man Insurance Is Available?
Companies can buy several different kinds of policies to cover key employees. These include:
Term Life Insurance
Term life insurance provides coverage for a specified period of time, usually between one and 30 years. It is usually the least expensive kind of life insurance because the policy expires when the term is up and you don’t recoup any of the cost unless the covered person dies.
Whole Life Insurance
As the name implies, whole life insurance (also called permanent or universal life insurance) covers an individual for as long as they live. The benefit of buying whole life insurance is that the company will build equity in the policy as it pays the premiums. And it can borrow against the cash value of the policy as well. This can provide a financial cushion if the insured person leaves the company voluntarily or retires.
Unfortunately, whole life insurance can be prohibitively expensive. Premiums are typically five to 10 times higher than those for a term life policy.
Survivorship Life Insurance
Survivorship insurance is a type of key man insurance that covers both parties in a partnership under a single policy. The policy pays the surviving partner if one of the two parties dies. These policies are particularly attractive to business partners who anticipate that their heirs may claim a portion of the business. Although they are not inexpensive, they are usually less costly than insuring both partners individually.
Buy sell agreements are legal contracts between two or more company owners. In the case of a key man policy, each of the partners buys life insurance on the others. If one partner dies, the remaining partners receive the proceeds of the policy. They can then use the money to hire and train a replacement, pay business expenses or pay personal expenses for the family of the person who died.
Life insurance will not pay any benefit if a key person is disabled and unable to work. Therefore, it’s usually a good idea to purchase disability insurance as well.
Are the Policy Proceeds Taxable?
As a rule, death benefits on a key man policy are taxable unless the employer:
- Notified the insured in writing before buying the policy
- Obtained written consent for the insurance from the employee
- Notified the employee in writing that the employer is the beneficiary.
If the above conditions are met, however, the death benefit will not be subject to income tax.
Buying insurance is complicated, and it’s easy to wind up with too little or too much. At the Carmoon Group, we specialize in creating comprehensive insurance programs tailored for your unique business needs.Why not call us today to set up an appointment for your insurance review? Or, if you prefer, fill out our online form and we’ll get back to you right away.