What is Key Person Life Insurance?
B.A. Risk Management
Life Insurance Agent
Key person insurance, also referred to as key man insurance, is a type of life insurance that provides coverage to a key employee in a business.
In some cases, it could be the business owner and in some other cases, it could be a high-ranking executive whose presence is crucial for the business.
How Does it Work?
A key-person life insurance policy, just like a regular life insurance policy, is a contract involving three parties – the insured, the beneficiary, and the life insurance company.
- The insured is the key person who contributes immensely to the day-to-day operations of the business and is crucial for its long-term growth.
- The beneficiary is the business itself, which is set to receive the death benefit amount if something were to happen to the insured.
- The insurance provider issues the policy and pays out the death benefit to the beneficiary in the event of the insured’s death.
In the event of the key person’s death, the payout from the insurance policy can be used to offset the losses caused as a result of their absence, to recruit and train someone to take their place, to make up for the loss of sales and subsequently the loss of revenue caused by their absence, and for a variety of other purposes.
Best Places to Buy Key Person Insurance
Why is it Needed?
The success of a business often depends on the contribution of a handful of individuals who play a key role in its short-term as well as long-term growth.
While the contribution of every single employee is valuable in its own right, there are some individuals whose absence would have a devastating impact on the company’s operations.
With most small businesses, the business owner also happens to be the most valuable employee, as they lead from the front and take on multiple responsibilities – from bookkeeping to managing employees, handling important customers, setting goals for long-term growth, and so on.
In large organizations, high-level executives and decision-makers are the driving force behind long-term growth.
They are hard to replace, at least in the short term, and their absence can have a negative impact – delayed projects, loss of sales, and so on.
It should be noted that the key person need not always be a president or a high-ranking executive. It could be anyone – a top salesperson, a front line manager, or an exceptionally gifted creative talent – whose sudden loss can be difficult for the company to cope with.
A key man policy is specifically designed to provide life coverage to such people. It is also used to provide collateral for a business loan. Some lenders will require a business owner to obtain life insurance coverage to cover the balance of the loan if they are to pass away.
The Benefits of Key Person Insurance
The proceeds from the key person life insurance policy can be used for a wide range of purposes.
If the key person owned shares in the company, they are usually transferred to his or her family in the event of their death. In such cases, the payout from the policy can be used to buy back the shares from the key person’s family.
Offsetting Lost Revenue
The sudden loss of a key person can disrupt the day-to-day operations of the business, leading to a loss of sales and revenue. Such losses can be offset with the help of the proceeds from the life insurance policy.
For example, if an important project needs to be canceled as a result of the key person’s death, the subsequent loss of revenue can be offset with the help of the proceeds from the policy.
The money can be used for ongoing expenses and to settle debts, especially if there are loans that need to be immediately paid off in the event of the key person’s death.
Recruitment and Training of New Talent
The money can be used to recruit and train someone who can replace the key person and take on their responsibilities.
This is particularly paramount since businesses generally invest a lot of time and money to train and groom employees for key positions. If something were to happen to such key people, the company again has to invest a lot of resources to find a suitable replacement for them.
It is not a difficult task for large organizations since they have a large talent pool to choose from and the resources to train and groom up-and-comers for top positions (though it still can be difficult for large companies).
It is not the case with small and medium businesses, as they have limited resources and might find it difficult to cope with the loss of high-performers.
This is precisely why key person insurance is needed, as the company can use the proceeds from the policy for recruitment and training purposes without exhausting all of its resources.
Closing the Business
In some cases, a company might not be able to survive the loss of a key person. It mostly happens with micro and small businesses, where the business owner is also the most valuable employee and is in charge of practically everything.
If he or she were to pass away, the rest of the employees might have no option but to close the business down.
In such cases, the proceeds from the key person life insurance policy can be used to pay off debts, repay the investors, provide the employees with a severance package, and close down the business in an orderly manner.
Is Key Person Insurance Tax Deductible?
No, it is not. Since the insurance policy is taken out for commercial purposes and the death benefit is paid out to the company, rather than the family of the deceased, the premiums as well as the death benefit are not tax-deductible.
Here is a direct quote from the IRS tax code on life insurance premiums.
You can't deduct the cost of life insurance coverage for you, an employee, or any person with a financial interest in your business if you’re directly or indirectly the beneficiary of the policy. See Regulations section 1.264-1 for more information.
While it is certainly a downside, the money you spend on insurance premiums is minuscule compared to the payout you stand to receive if the key person were to pass away.
So, a key person life insurance policy can be worth investing in, especially if there are people – including yourself – whom your business simply cannot do without.
How NoExam.com Can Help You
The concept of key person insurance can be difficult to comprehend, especially if you do not have a firm grasp of life insurance in general.
The insurance experts at NoExam.com can assess your business needs and tell you if you need key person insurance or not.
If you do need it, we can also help you find the right product based on the size and scope of your business and several other factors.