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Why Key Person Life Insurance is Crucial for Small Business Owners
Small business owners know that their employees are their most valuable asset. But what happens if a key employee passes away unexpectedly? Key person life insurance is a type of policy that provides financial protection to the business in case of such a loss. Learn more about this important coverage and how it can benefit your business.
- updated last on April 29, 2023
What is key person insurance
According to Wikipedia, Key person insurance, also called keyman insurance, is an important form of business insurance. There is no legal definition of “key person insurance”. In general, it can be described as an insurance policy taken out by a business to compensate that business for financial losses that would arise from the death or extended incapacity of an important member of the business. To put it simply, key person insurance is a standard life insurance or trauma insurance policy that is used for business succession or business protection purposes.
The policy’s term does not extend beyond the period of the key person’s usefulness to the business. Key person policies are usually owned by the business and the aim is to compensate the business for losses incurred with the loss of a key income generator and facilitate business continuity. Key person insurance does not indemnify the actual losses incurred but compensates with a fixed monetary sum as specified in the insurance policy.[1]
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What is the purpose of key person insurance
The main goal is to protect the company’s interest and compensate for the losses once a key member of the business suddenly dies. It will not cover the company’s entire financial loss, but it will give the fixed amount stated within the policy. Therefore, the company has the right to apply for coverage that they think is worthy of a key person’s life plan.
Employers usually want to offset all the costs involved in:
- the recruitment process, hiring, and training
- the replacement of loss profit of the company until the training of the successor is done
- the payment for all debts
Moreover, the money from life coverage can also be used to buy shares owned by the company’s deceased member through a buy-sell agreement. Also, some companies generously give it to the deceased family as a perk of their trusted employees in case of the key person’s demise.
The determining process of the key employee is vital. Hence, it is good if the company will establish set guidelines to find out who are their key employees. Also, if an employee has a database of clients and attracts a considerable amount of profit to the company, they are worthy of insurance. Another reason is if the employee’s work significantly impacts the business, and their loss will cause massive damage to the business.
The following are ways of how a key person life insurance policy can save your business.
- Recruitment Process and Training of Replacement
Just like any other life insurance coverage, it is tax-free. Hence, it can help fund the recruitment process and the training of the key person’s successor. It can also be used to increase the salary of the replacement as he or she may have a higher-level skill than the other one. The company should consider the hiring process and the training of the replacement when getting this insurance.
- Replacement of Profit
Aside from death, an accident can make a key person unable to perform their duties within the company. Therefore, it will result in a loss of profit for the business. Most companies nowadays insured their buildings and other tangible assets, but they forget their employees’ most important assets. If a key employee becomes incapacitated or died, the business will suffer from loss of profit and other expenses. The good thing is the fact that it is tax-free.
- Payment for Debt
It might affect the company’s credibility as creditors and lenders may not trust your company after the death of a key person. The benefit that the business can get is essential for continuous cash flow and keeps banks and other lending institutions from foreclosing loans, credit lines, and raising interest rates. Therefore, having insurance can also increase clients’ and employees’ trust regarding the stability of the company.
Key man insurance vs life insurance
Almost all business invests in the workforce as it is one of the keys to a successful and lasting business. Most of the time, the most trusted and reliable employee in the company is called a key person. A key person is a vital asset to the company. Furthermore, they have all the skills and knowledge that the company needs. The contribution of the key person to the company’s success is valuable.
However, unfortunate events can happen anytime that can make a crucial person unable to fulfil their duties in the company. When it happens, the company has adverse effects, but measures can be taken to avoid damages.
Keyman life insurance differs from other life insurance policies in that the business is both the owner and the beneficiary of the policy. The employee essentially has no rights or participation in the policy
.
If a key person is precious to the company and an asset, it is worth getting life or health insurance. A key person’s life insurance policy can safeguard the company in case of unforeseen events. A loss of a person vital to the company means a loss of income.
How Can Key Person Life Insurance Help?
It is also known as the key man life insurance policy. It is a type of life plan that a company can purchase on behalf of their employee. The best thing about getting one is that it can shoulder possible financial losses from the demise or incapacity of a key person. Hence, it is a form of standard life coverage that many companies use for security purposes.
A key person could be the CEO, director, partner, salesperson, manager, or someone with special skills needed by the company. If you think a person is significant to the company, then the organization can choose to acquire a key life policy. For instance, a small business can get coverage for its owner, founder, or key employee. There is no limit on how many employees you can enrol in the policy. It is valid as long as the company pays the monthly premium.
If you are still deciding on the key person, you can look at your business and point out irreplaceable people for the company.
Key man life insurance tax treatment
Key person life insurance can have different tax treatments depending on the circumstances. Generally, premiums paid by the business are not tax-deductible, but the death benefit is usually tax-free. However, if the company benefits from the policy and receives the death benefit, it may be subject to income tax. It’s essential to consult with a tax professional to understand the specific tax implications for your business.
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What type of key person life insurance policy to buy
A company can also choose from permanent or term life coverage. A term policy is a good choice if the insurance aims to pay for a business loan and other temporary payments.
However, permanent insurance is the best choice if the company wants long-term gain. This type of insurance has a death benefit plus investment through a cash value. Also, you can choose between whole and universal life.
Furthermore, a key person life insurance policy can also be applied with other benefits like retirement. If you want this kind of benefit for your employee, then permanent life coverage is valuable. In case of the insured’s sudden death, the company can get the death benefit. However, if the insured reaches the retirement period, the insurance can turn into a retirement benefit. Another great option is to transfer the policy to the employee before retirement.
Key man insurance calculator
Insurance companies typically base the amount of critical person insurance needed on a multiple of five to seven times the employee’s current salary compensation and benefits. For example, using a multiple of five: $1,000,000 would be the insurance needed for a key person with a salary package totalling $200,000.
Who is the owner and who is the beneficiary on a key person life insurance policy
In a key person life insurance policy, the business is the owner and beneficiary of the policy. If the key employee covered by the policy passes away, the company will receive the death benefit payout. This type of insurance provides financial protection for the business in case of the unexpected loss of a key employee who is crucial to the company’s success. It can help cover expenses such as hiring and training a replacement, paying off debts, and maintaining business operations during a difficult time.
Best key person insurance
When choosing a key person insurance provider for your small business, it’s essential to do your research and compare options. Some of the top providers in the market include AIG, MetLife, and Nationwide. Each provider offers different coverage options and pricing, so getting quotes from multiple providers is essential to find the best fit for your business. Additionally, working with an experienced insurance agent or broker who can guide you through the process and help you make an informed decision is essential.
Key person life insurance cost
The cost of key person life insurance varies depending on factors such as the age and health of the key employee, the amount of coverage needed, and the type of policy chosen. Generally, term life insurance policies are less expensive than permanent ones. Small business owners need to consider the potential financial impact of losing a key employee and weigh that against the cost of the insurance policy. In many cases, the procedure cost is a small price for the peace of mind and financial protection it provides.
Key person insurance quote
To get a quote for key person life insurance, small business owners should contact an insurance agent or broker specialising in this type of coverage. The agent will ask questions about the key employee’s age, health, job responsibilities, and other factors to determine the appropriate amount of coverage and type of policy. It’s essential to shop around and compare quotes from multiple insurance providers to ensure you get the best coverage at the most affordable price. Remember, the cost of the policy is a small price to pay for the financial protection it provides in case of unexpected loss of a key employee.
How to get a key personnel insurance policy?
Knowing how much you need is essential if the business is interested in acquiring a key person life insurance policy. It all depends on the particular needs of the business. The best advice is to obtain as much as the company can afford. Hence, consider how much money the company needs to survive the critical person’s loss until it can recover.
Above all, the business should only acquire a policy they can afford. Also, consider the short and long-term goals right after the tragedy. If you have already decided to get a Key person life insurance policy, Coach B. Life Insurance can guide your company. They can cater to the needs of all types of businesses, whether small or big companies. You can contact them at 1-800-342-1537; an expert agent will gladly help you.
Frequently Asked Questions
What is the difference between key person insurance and life insurance?
Key person insurance is a type of life insurance policy that is taken out by a business on the life of a key employee or owner. The company pays the premiums and is the beneficiary of the policy. In contrast, traditional life insurance policies are typically taken out by individuals to provide financial protection for their loved ones in the event of their death.
What are the advantages of key person insurance?
Key person insurance provides financial protection for a business if a key employee or owner dies or becomes disabled. The advantages include helping to cover the costs of finding and training a replacement, maintaining business operations during a transition period, and avoiding financial losses or bankruptcy. It can also provide peace of mind for business owners and stakeholders.
Is key person insurance necessary?
Key person insurance can be crucial for businesses that rely heavily on one or a few key employees. If the loss of a key employee significantly impacts the company's revenue or operations, then key person insurance is necessary to protect the business from financial losses. It's vital to assess the risks and needs of your specific business before deciding if key person insurance is essential.
About Coach B.
After starting his financial career with Phoenix Home Life Insurance Company back in 1992, Scott decided he wanted to provide people with an easier and more enjoyable way to buy life insurance. That was the start of Coach B. Life Insurance, whose mission is to be transparent, honest, and helpful to customers — without ever bugging or pushing them.
In the years since then, he has worked tirelessly to improve the process of shopping for insurance. His goal is to make sure that everyone who comes to Coach B. — whether they end up buying a policy or not — has the best possible experience.
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