Financial Journey Articles
Since many small businesses rely on a few key people, the loss of a key person can be devastating to the business. Here is some information every small business owner should know about:
Key Person Insurance
You've worked hard to establish your business. You strive to hire highly skilled, invaluable associates to help run the company. Like most companies, there is probably at least one employee everyone agrees is "priceless." It's practical business to consider where you, or the company, would be without a key employee?
Hopefully, you'll never lose an invaluable Associate. But if you do, having a key person insurance life policy can provide tremendous peace of mind.
Should the company consider acquiring a key person life insurance policy? The company's structure, current business plan and the potential financial hardship due to the death of a key employee should be analyzed. Working with an experienced financial advisor can help you create a business insurance strategy and determine if this coverage is right for your company.
When considering if your business situation requires key person insurance, keep these typical situations in mind:
- Loss of management skills and experience,
- Disruption in sales or business production,
- Weakening of the company's credit rating,
- Expenses associated with recruiting and training a suitable replacement and
- Creditors may require repayment of company indebtedness, if any.
Before buying key person insurance, examine these circumstances
Assess whether the company's loan or line-of-credit payments are sufficiently insured, in the event your company experiences financial setbacks due to the untimely death of a key employee. This is especially true if you have co-signed
Is your business-continuation plan thorough enough to maintain operations if your firm experiences a monetary or management hardship? Without one, the company may be in trouble even if it has sufficient capital and cash flow.
If you've covered both of these aspects, but still feel you'd have asset flow problems without the key person, then you're set to explore this insurance.
How it works and the advantages
Your business purchases a life insurance policy on a key employee's life, equal to the amount the company has determined it needs indemnification for the loss of the key employee. The company pays the premiums - which vary depending on the key person's age, physical condition and health history - and preserves all ownership rights to the policy. Any cash value accrues in a tax-deferred manner and may be accessed by the business, allowing your organization to redeem the cash values of the policy through policy withdrawals and income tax-free loans.1
Upon the employee's death, the proceeds are paid to the corporation - generally income tax-free. Now your firm can use the death proceeds to sustain operations during the transition between the executive's death and the hiring and training of his or her eventual replacement.
Furthermore, because the policy is owned by the company, it may be continued even after the key person leaves. For instance, if your partner retires, your business may offer the employee the policy as part of his or her retirement package. Once the policy is in the employee's name, he or she should designate a different beneficiary.
Disadvantages
- Premium payments are not income tax deductible,
- Corporate creditors can make claims against cash values of corporate-owned life insurance and
- Death proceeds, although exempt from the ordinary income tax, may be subject to the corporate alternative minimum tax if the company is established as a C corporation.
With a thorough discussion of your business arrangement and plan with your financial advisor - who has access to our subsidiary Planning Corporation of America, providing sales, marketing and administrative support services for insurance and annuity alternatives - key person insurance may be a precaution your company deserves.
For more information about selecting the right life insurance for your business needs, contact a River Valley Investments financial advisor.
1Potential tax-free income assumes (i) properly structured withdrawals to tax basis and policy loans thereafter, which will reduce policy values and death benefits, (ii) the policy is not a Modified Endowment Contract as defined in Internal Revenue Code Section 7702A, and (iii) the policy remains in force until death.
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