We all have key people in our lives, don’t we? People who make a difference, without whom things just wouldn’t be the same. The same holds for businesses. Some individuals within an organization are so integral to its operation that losing them could be devastating. This article will delve into key person life insurance and how it can protect your business against the unexpected loss of such a critical employee.
Understanding the Key Person
A key person in a business is often someone without whom the company might struggle to survive. These key people could include co-owners, top executives, or other pivotal members with unique skills and experiences vital to the company’s success.
Interestingly, a survey reveals that only 22% of small business owners have discussed safeguarding against the loss of key personnel with their financial professionals. This suggests a massive opportunity for businesses to be more proactive.
What Is Key Person Life Insurance?
Key person life insurance offers income tax-free death benefits, providing immediate funds to cover lost profits attributable to the critical person. This reduces the need to access cash, extra credit, or even sell assets.
Some benefits of key person coverage include:
- Maintaining lender confidence during the transition period of finding a replacement.
- Freedom for the business to decide who to insure without IRS approval.
- Helping preserve business continuity by providing immediate liquidity upon the passing of a critical person.
Determining Coverage Amounts
- Multiple key person’s salary.
- A percentage of profits attributable to the employee.
- Business debt obligations of an owner.
Considerations
- Determine the right amount of life insurance coverage.
- Note that policy cash values are a balance-sheet asset that can grow potentially tax-deferred.
- Remember, premiums paid by the business are not tax-deductible.
How It Works
- Identify Key Persons: Know the key players in your business.
- Obtain Written Consent: The key employee provides written consent.
- Business Becomes Owner and Beneficiary: The business pays the nondeductible premiums, and receives the death benefit, usually federal income tax-free.
A Mock Business Example
Let’s illustrate this with a fictional example.
Imagine a small tech startup, “TechGuard.” Within this company, Sarah, the lead developer, has unique knowledge and expertise that has been vital to TechGuard’s innovative products. Her sudden loss would leave a significant void.
TechGuard decides to take out a key person life insurance policy on Sarah, considering her salary, the profits attributable to her, and her role in the company’s success. This decision means that if anything happens to Sarah, TechGuard would have the financial support needed to find a replacement without affecting their cash flow or putting additional financial strain on the business.
Conclusion
Key person life insurance isn’t just about numbers and policies. It’s about recognizing the value of individuals within an organization and taking steps to ensure that their loss doesn’t lead to financial disruption or instability.
It’s a way to show that you value not just what a person does but who they are and that you have a plan to honor their contribution to your business, even in their absence. Talk to your financial professional today to learn how to protect your business with key person life insurance. It’s a wise investment in your business’s most precious asset – its people.
