Does your business include someone whose contribution is vital to the survival of your company? If yes, then key person insurance should be a part of your business continuity and succession plan—especially if you’re a small business owner
Business owners recognize the benefit of insuring their firm’s valuable assets, such as office equipment and inventory, to cover property loss. Such assets, however, may not be as valuable as key persons. Consider a top salesperson who is unsurpassed at bringing in new business or an expert manager who handles the day-to-day operation of the business. Key persons are a business’s most valuable resource. Their energy, expertise, and hard work enable the business to be successful in today’s highly competitive marketplace. If a key person dies suddenly, profits could be impacted and there might be considerable costs incurred in recruiting, hiring, and training a suitable replacement.
Life insurance should be part of a business continuity strategy. It can provide the business with tax-free funds when needed to help:
A key person is anyone associated with the business whose special skills make a major contribution to the bottom line. Some examples include the active business owner(s), employees who have strong relationships with valued customers, and any employee who has specialized knowledge and expertise that can’t easily be replaced.
If an owner, co-owner, or a key person became disabled, your business could be faced with the same financial situation as if the person had died—but no life insurance policy would pay out. However, with a key person disability insurance policy you could use the monthly cash benefit as working capital; to recruit, hire and train a replacement; pay off debts; and much more.
Calculating the potential financial impact of the loss of a key person’s services to a business may not be easy, and no set formula or rule can be used for all business situations. In many cases, the amount of key person insurance is established in a somewhat arbitrary fashion. Some questions that may be considered when determining a reasonable coverage amount can include:
To implement key person life insurance in a corporate context, the corporation is the applicant for the life insurance coverage to be arranged on the life of the key person, and the named owner and beneficiary of any policy that is issued. The premium is a non-deductible expenditure by the corporation and the life insurance proceeds are non-taxable when received.
For private corporations, another benefit of a key person life insurance policy is the life insurance death proceeds create a credit to the corporation’s capital dividend account, equal to the proceeds less the adjusted cost basis of the life insurance policy. The capital dividend credit can then be used to pay tax-free capital dividends to the shareholder(s).
When considering key person life insurance, clients should always consult with all their professional advisors to help assess the risk involved and the appropriate amount of coverage to be applied for.
*This article provides information of a general nature only and is not intended to provide legal or tax advice. Clients are encouraged to consult with their own professional tax and legal advisors about their particular circumstances.
Feel free to contact us.