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What Is Key Person Insurance and Why You May Be in Trouble Without It

What Is Key Person Insurance and Why You May Be in Trouble Without It

When you launch a small business, you handle many details. One detail you may have overlooked is key person insurance. In fact, you may not even know what it is. However, key person (sometimes called “key man”) insurance can be an important way of keeping your business up and running in the event of the unthinkable.

No one wants to think about what would happen in the event of a key person’s death or life-changing accident. And, if you have thought about it, you may think you have it covered with life insurance and disability insurance policies. But while those policies are designed to protect an individual or an individual’s family, key person insurance is designed to protect your business. If your small business relies heavily on one or two people – say yourself and a partner –it’s time to consider key person insurance.

Each company is different, but, in most cases, key person insurance typically covers the founder, the owner (often the same person in a small business) and a key employee or two. Think about the people whose absence could bring your company to a stand-still and you have found your key people. Quite simply, without this insurance, the unexpected death or disability of a key person can also mean the death of the company you have worked so hard to launch.

To determine if you need key person insurance, here are a few questions to consider:

  1. What would happen to the business in the event of the unexpected death of a key person?
  2. How much income or revenue could be lost in the time it would take to replace that person?
  3. How much time and money would it take to locate, interview and hire someone to replace that person?

You answers to these questions will help you determine how much coverage you need. With a key person insurance policy in place, your company would pay annual premiums and would be the beneficiary of the policy. The premiums would vary depending upon that person’s age, physical condition and medical history.  Any cash value of the policy accrues in a tax-deferred manner and your company would be able to redeem the cash values of the policy through withdrawals and income tax-free loans.

If a key person dies, the company receives the benefits. The coverage can be used to keep the company afloat while you search for someone to handle that person’s responsibilities. It can be used to cover day-to-day expenses, to pay off any debt, to pay salaries or to distribute money to investors. If necessary, the policy also can be used to close the business in an orderly fashion.

Since the company owns the policy, that ownership is retained if a key person leaves the firm or retires.  Your company could offer the policy as part of a retirement package. However, the retiree will need to designate a different beneficiary.

How much should you expect to pay for key person insurance? Policies differ, but in most cases, term insurance is your best bet. As the name implies, a term policy will pay benefits for a set period of time and, as a result, it will have lower premiums than other more open-ended policies.

Think about how much money your business would need to get back on its feet after the loss of a key individual. Purchase a policy that both fits your budget and addresses the firm’s short-term needs after a tragic loss.

Who might not need key person insurance? If you are a sole proprietor, you probably do not need the protection of a key person policy. Your personal life insurance policy will cover the family members who depend on your income in the event of your unexpected death.

Are there any disadvantages of key person insurance?  The premium payments are not income tax deductible. In addition, your company’s creditors can make claims against cash values of company-owned life insurance. If your firm is established as a “C” corporation, death proceeds may be subject to the corporate alternative minimum tax.

None of us likes to think about life insurance. But when it comes to your small business, you have worked too hard to not be prepared in the event of an unexpected death or disability. Talk to your financial planner and to an insurance agent familiar with small businesses to see if key person insurance is right for your company.



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by Tricia Drevets //

Regular Contributor to Businessing Magazine. Tricia Drevets is a freelance writer who specializes in business and communication topics. A community college speech and theater instructor, Tricia lives in beautiful Southern Oregon.

Opinions expressed by contributors are their own.