Imagine this: you and your college buddy started a small business that’s now thriving. You’ve got a dozen employees, and your business is worth over $10 million. But then, disaster strikes. Your partner passes away without a will or a plan for the business. Her share goes to her not-so-nice husband, who starts messing with the business, causing sales to plummet. You start thinking about a career change.
But what if you could have avoided all this? That’s where key person life insurance comes in.
What’s Key Person Life Insurance?
Key person life insurance is a policy that protects your business if a crucial employee or partner passes away. It’s like regular life insurance, but the business owns the policy and gets the payout if the insured person dies. Usually, the person insured and the policy owner are the same, and the beneficiary is a family member. But with key person insurance, the business is the beneficiary.
Who’s a Key Person?
A key person is someone vital to your business’s success. Their absence could threaten the survival of the company. This insurance can be used to prevent a surviving spouse from interfering in the business, or to compensate for the loss of a vital employee’s skills or expertise.
A key person could be an employee with unique skills, like the head of R&D, or someone whose contacts are crucial for the company’s growth, like the head of sales. It could also be an executive responsible for daily operations, or a partner whose capital supports the company’s operations.
How Does Key Person Insurance Work?
Key person insurance works like any other life insurance policy. But since your company owns the policy, it’s your responsibility to apply, not the insured employee’s. The key person must know about and agree to the insurance. Your business can require key person insurance as a condition of employment.
If the death benefit is substantial, the employee may need a medical exam to confirm they’re healthy enough for coverage. Once the policy is in effect, you pay premiums to keep it active. If the insured person dies while the policy is active, your company gets the death benefit, which is usually tax-free.
What Does Key Person Insurance Cover?
Key person insurance is there to cover costs when a covered employee dies. These costs could include finding and training a replacement, replacing the revenue the person was responsible for, covering additional costs due to the person’s death, offsetting indirect losses, buying out their heirs, or paying debts that come due as a result of the person’s death.
Sometimes, the death of a key employee or partner can mean the end for the company. If the business can’t stay afloat after they’re gone, key person insurance can cover the costs of winding up the business.
Types of Key Person Insurance
Key person insurance can take several forms. It’s usually a type of life insurance, but you can also take out disability insurance policies on key employees and partners.
Do You Need a Key Person Life Insurance Policy?
If the death of an employee or partner would seriously harm your business, you probably need a key person life insurance policy. Start with those whose loss threatens the company’s long-term profitability or existence.
Key Person Life Insurance FAQs
Key person insurance isn’t on many business owners’ radars. If this is your first deep dive into the subject, you probably still have questions.
How Much Does Key Person Insurance Cost?
The cost of key person insurance depends on several factors, including the type of policy, the insured person’s age, gender, health status, the size of the death benefit, and the insured person’s occupation and lifestyle.
Where Can I Get Key Person Insurance?
Key person insurance is more niche than life insurance for individuals, so few insurance companies sell it. If you have an insurance agent who helps you with other types of business insurance, ask them to help you.
How Much Key Person Insurance Coverage Do I Need?
How much key person insurance you need depends on several considerations about the individual you’re covering: replacement cost, earnings contribution, buyout cost, and business risk.
Is Key Person Insurance Tax-Deductible?
Unlike most business expenses, key person insurance premiums are not tax-deductible or tax-advantaged in any way. Your premium payments reduce your company’s profits dollar for dollar.
Final Word
Human capital is among a business’s most important assets. If your business would struggle to recover from the death of a key employee or partner, you’d do well to look into key person life insurance. Should tragedy strike, you’ll be glad you did.
