Looking to keep your company protected with Key Person Life Insurance? Who is the best life insurance company for a key person? Is it difficult to get a policy approved? Having an important key employee replaced can take a lot of money and time. The time it takes to transition and replace your key person may result in lost customers. Let’s see how to avoid this potential disaster with life insurance.
Key-Man Business Life Insurance
What is it?
You may have noticed already that there are a few terms that keep popping up.
Key person, key employee, and key man business life insurance mean the same thing and can be used interchangeably. Key man life insurance is taken out by a company that keeps someone covered whose absence from a company would produce significant financial difficulty.
Essentially, whoever is important to the continuation of an organization can be a key man. The company addresses who the key person is, and life insurance is purchased by the company on said individual. The company then pays the premiums, and in the event of the key man’s death, funds are allocated to the life insurance beneficiary of the key man – the business.
Let’s dive into this with some more detail.
Key Person Life Insurance
One of the most often used applications of life insurance is to give various benefits to the key person of the company. A key person life insurance plan can be set up easily to provide a death-benefit-only plan, or a nonqualified deferred compensation plan.
A key man insurance plan can also provide a benefit to the business by insuring the value of the key person (or people) as a human asset. The company has to protect against the negative economic impact that a loss of such a person can have. These losses would include: continued operations, customer relationships, and credit worthiness of the business.
Having a key person life insurance policy for your best employees also solidifies their worth to your company, making the relationship stronger.
More features of key person insurance
Key person life insurance provides a death benefit that can aid in covering financial losses if your key person employee were to die. This helps in maintaining the continuation of the company for the sake of customers, staff members, and creditors.
- You can use the death benefit to develop and recruit a replacement for a key employee
- Coverage is a company asset that improves your business’ creditworthiness when borrowing funds for commercial purposes
- The cash value of the policy might be available to your company via a loan or withdrawal if required
- The premiums, which are non-deductible, are paid by the company
Life Insurance Blog can assist you in going through the proper channels and establishing your company with the most suitable key person life insurance policy at the best rate.
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Purchase Key Person Insurance to Keep Your Company Protected
This post will go over key-person life insurance: what it is, who requires it, and how to get the best rate possible. We will also address the tax ramifications a company could face upon taking out key man life insurance policy.
Is Your Company Protected with Key Man Life Insurance?
Who are your Key Employees?
Key employee business life insurance must concentrate on a few primary categories: (1) company survival or continuity, (2) troublesome or impossible to replace, (3) bank loan or SBA financing.
- Company survival or Business continuation: Key employee insurance must be used for any individual within the company who’s sudden passing would impact the survival or continuity of the company. Key Person Insurance provides creditors with comfort knowing that the business won’t miss a beat if the insured individual passes away.
- Impossible to replace: Key person life insurance must be used for any staff member whose unanticipated passing would make it troublesome or impossible for the company to get replaced.
- Bank loan or SBA financing: Key man life insurance will be needed for any business owner who wants to take out a bank loan or an SBA.
Who Is a Key Person?
Typically, a key person is your employee whose death before retirement will have an adverse financial effect on your business. This adverse effect can be the extra expense of hiring a replacement, loss of company profits, as well as the loss of credit standing.
Key Person Employee Examples:
Let’s look at the most common examples of keyman life insurance:
- Owner: The owner of a business, particularly if the loss impacts the long or short-term viability of the company, like negatively impacting the business’ status with creditors, or the organization’s capacity to obtain financing.
- Technical: A software engineer or scientist who produced the business’ intellectual property would surely be thought of as a key-man insurance candidate.
- Sales Leader: A sales leader, particularly if the individual has turned into the main employee for most of the business’ primary customers, and generates a decent portion of the company’s revenue.
Identifying Your Key Person
A good test for identifying your key employees is the size of their salary. Of course, a high salary is not the “end all be all” for picking a key employee. However it is good way to identify that this employee is believed by management to be an asset and is valuable to the business.
Another way to ID a key employee is if they have a role in decision-making. Does your employee make important managerial decisions? Do they have influence over the decision-making processes? If the answer is yes, then they could be considered invaluable to your company’s success. Such a person is a key employee.
Some other key employees are those who work directly in the areas of:
- Accounting
- Production
- Sales
- Management
Sales: Sometimes a person who has clients or customers can be identified as a key man. Their role is invaluable because their death may result in the loss of a huge portion of the business.
Capital Source: An obvious key person is someone who represents a significant source of capital in the company. This can be direct or indirect. For example, through their reputation in the community or their influence with lenders. There are times when a lender will request a specific co-signer when a business loan is taken. Naturally, if the key man were to die – it cause a horrible effect on the company’s available sources of capital.
Talent: If your employee has a unique talent, they may be considered a key person. If a key person holds a unique and valuable position, regardless of their job duties, and their talent would be difficult and costly to replace. This would also be costly to the business if the keyman died.
Establishing How Much Key Man Life Insurance is Needed
There are numerous approaches to establish how much key-person insurance a company should take out.
Overall, the amount to be determined should be what the company can afford without affecting other aspects of the company. A few areas to keep in mind are replacement costs, income multiple, and the company’s revenue percentage.
Replacement Cost
If a key employee needed to be replaced, what would it cost the company?
Factors to take into consideration would be the time needed to locate a substitute. You would also need to have the staff member trained and informed about the ins-and-outs of the company. Meanwhile, income would be lost while this is taking place because of the key employee’s absence. As such, the loss of revenue should be included.
The average figure is ten times the key person’s income.
Income/Salary Multiple
Although this is a simple valuation approach, it fails to take the company or key employee into consideration. You can just take the existing key employee’s revenue and multiply it 5 to 10 times.
Company Revenue Percentage
What is the key person’s percentage of the contributions made to the overall revenue of the company? After the contributions of the key person are figured out, that figure must be multiplied by the amount it would require to get someone to replace the key person. This timeframe is generally 1 to 3 years.
A fast method for determining the value of a key person is to establish the staff member’s contribution percentage to the gross or net profits of the company. Afterward, that figure should be multiplied by two years for the gross profit percentage. For net profit percentage, the amount should be multiplied by 5 years.
Example
For instance, if 20% is contributed by a key employee towards the business’ net profit and the organization’s annual net profits are $1,000,000, then $200,000 is contributed by the key employee yearly. As such, key man life insurance policy of $1,000,000 would be required with the net profit percentage [(10% X $1,000,000) X 5 years].
Best Company for key man life insurance?
Unfortunately, there is no “Top 10” list specifically for key man life insurance. The best company will depend on the specific health and lifestyle of the insured. For example, if your key employee is in perfect health – then maybe Banner Life will have the best deal. However, perhaps they have a health issue like diabetes – then another carrier like Prudential may offer a better deal. It all depends on the specific details of each individual.
Key Person Insurance Underwriting Requirements
Here are the basic underwriting requirements for a key man life insurance policy:
- An underwriter will approve life insurance face amounts between 5-10xs the earned income.
- Bonuses could be included as well.
- Several carriers demand that the bonus is regularly paid as per the business’ bonus plan.
- Further, if the company has awarded the key person with ownership interest, the right company net income percentage can be added to the person’s revenue.
- Prior to the coverage going into effect, the key person employee must sign an Employer-Owned Life Insurance Acknowledgement and Consent form.
- Tip: For an employee to become a key person, several states have certain qualification requirements.
Underwriting Questions
A life insurance company will look into how the company established the life insurance amount needed. Key man insurance underwriters need to find out about the key employees:
- Type of Company: Which type of company is your business? C Corp, S Corp, LLC, Sole Proprietorship, etc.…
- Revenue: the income level of a key man will be used by insurance companies to aid in establishing the amount of coverage they’re willing to provide.
- Experience: an experienced key man will be more valuable to the company as time passes. As such, the level of experience aids life insurance carriers in establishing the worth of a key employee.
- Position in the company: The role of the key man in the company is vital since not just anyone is regarded as worthwhile for the key-man role.
- Skill set: much like the position in the company, the skill set of a key man aids in determining if a staff member is capable of being a key man.
Types of Key Man Life Insurance
Choosing the proper coverage type is not as easy as it sounds. What type of key person life insurance should you choose?
Occasionally, it’s more prudent to select certain types of life insurance. Is Term vs Whole Life the best or is some other policy better? It depends on a variety of factors that we’ll address below. That said, every individual circumstance warrants experts to figure out the advantages and disadvantages of whole life versus term life insurance.
Term Life Insurance Policies
Term Life insurance is temporary coverage.
- Term life is the cheapest life insurance. It comes in numerous term lengths, and for the term’s duration, the premium is fixed. Term lengths range from 1 to 30 years. However, 1 and 5-year terms are an option.
- One company represented by us provides a maximum of $1,000,000 worth of coverage for a key employee without an exam needed. As such, if you require coverage and the key employee doesn’t want to go through with an exam, this is an ideal choice.
Permanent Life Insurance Policies
There are a pair of choices when it comes to permanent life insurance: Universal and Whole Life
Whole Life
Whole Life insurance accumulates cash value and lasts for the duration of the insured’s lifetime. One advantage of cash value life insurance is the option to use funds through tax-free policy loans. Liquidity can be supplemented to your company when you truly require it. Further, it can stimulate a key person to remain with the company until their policy has completely vested. Just like with term, make sure you only buy from the best whole life insurance companies.
Universal Life
Universal Life comes in Variable, Indexed, and Guaranteed policies.
- Guaranteed Universal Life generally will last your lifetime. It accumulates cash value at a slow rate in comparison to indexed or whole life insurance, however it is not designed for loans or withdrawals. It is designed to provide lifetime coverage at an affordable rate.
- Indexed Universal Life Insurance may be worthwhile because cash value is retained through it. The cash value can add more reasons for your key employee to remain longer. Also, in the event of the key person departing, a third party can purchase the policy as a life settlement. Based on the age of the key employee, a business can obtain a better rate if the coverage no longer becomes necessary.
What Kind of Coverage is Ideal for Key Man Life Insurance?
There isn’t one type that can please everyone. Every product has its highlights and advantages. Also, several come with vital life insurance riders, like critical illness, disability, and terminal illness riders. Feel free to contact us to discuss your choices. We will aid you in selecting a suitable for your needs, as well as your company’s.
What Term Length is Needed for Key Person Life Insurance?
If you choose term, then the term length should be connected to a certain date down the road, like retirement. For instance, if a key individual is 45 years of age and the anticipated retirement for that person is 65, then a suitable term life insurance length would be 20 years.
Different kinds of life insurance, like universal or whole life, may be more advantageous in stimulating the key employee if they have access to the cash value.
Is Key Man Life Insurance Tax Deductible?
Key employee insurance premiums are not tax deductible. The general rule is that no deduction will be allowed for the following:
- The life insurance premiums on any policy if the taxpayer is indirectly or directly the life insurance beneficiary under the contract or the policy.
Proceeds for Key Man Life Insurance Tax Treatment
Company proceeds from the key employee life insurance are regarded as revenue, and the company will be taxed assuming Notice and Consent requirements below are met.
Requirements for Consent and Notices
The requirements for consent and notices are met if, prior to the contract being issued:
- The key person is told in writing that the applicable policyholder plans to insure the key person’s life and the maximum face amount for which the key man may be insured upon issuance of the contract,
- The key person offers written consent to being insured as per the contract and that this coverage might keep going upon termination of the insured’s employment, and
- The key man is told in writing that the relevant policyholder is the beneficiary and will receive proceeds paid upon the employee’s death.
Further, an additional form has to be accompanied by the employer’s yearly income tax return. These details are needed:
- The amount of staff employed at year’s end.
- The amount of staff who are insured at year’s end as per employer-owned life insurance contracts.
- Under these contracts, the total of life insurance in force at year’s end.
- The employer’s contact information and taxpayer ID as well as the kind of business that the employer has.
- If the employer has the proper consent for all insured staff members, and if not, the amount of insured staff who lack this consent.
How to get Affordable Key Person Life Insurance
Life Insurance Blog is an independent broker. Our licensed independent life insurance agents are experienced and have access to the best companies. We’ll provide you customized quotes and help you through the entire process. We understand that selecting the perfect policy can be a difficult and long process, but we’re here to help you.
Contact us if you would like learn more about how Key Person Life Insurance can contribute to the succession of your business. You can also speak directly with one of our Licensed Advisors, we’re here to help! For more information about your insurance needs, visit our Business Life Insurance page.
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