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Why Business Owners Must Consider Key-Person Insurance

By MarksNelson on September 25, 2017 in Articles, Succession Planning, Terry Staley CPA, MBA, CExP
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It takes a great leader to run an organization, but without strong leaders, a business stands little chance for success. More likely, a business has several “key employees” that contribute overall profitability and long-term success. So when it comes to insurance, it is essential that the business owners look beyond insuring their business in the event of their own demise but weigh the risks of losing one of their key employees.

Fortunately, there’s a relatively easy way to safeguard the business. Appropriately enough, it’s called “key-person” insurance.

Typical situation: A company takes out a life insurance policy on someone whose presence is considered crucial to the business operation. In some cases, the proper insurance protection can mean the difference between solvency and bankruptcy for the business. The life insurance proceeds from the policy could be used for any or all of the following purposes:

  • Finding, hiring and training someone to take the place of a deceased worker
  • Paying bills to maintain the company’s good credit rating
  • Paying off business loans, which lenders may call after the death of an owner/officer
  • Making up for the loss of revenue caused by the subsequent disruption to the business

Who should be covered by a key-person policy? Start with the owner and president of the company. The rest of the group depends on the type and size of the business. For example, it may be worthwhile to insure a top salesperson, creative talent or front line manager.

Premiums are generally not tax deductible. However, when the key person dies, the business receives the proceeds of the policy tax-free. In addition, the life insurance proceeds generally are not part of the key person’s estate. But if he or she is the sole or controlling shareholder, the proceeds may be taken into account for determining the value of the stock for estate tax purposes.

Finally, as long as there is a legitimate business reason for the insurance, the business should be able to avoid any accumulated earnings tax problem.

What happens if the key person leaves the firm for some reason? Generally, there are three options for the business owner to ponder. The company may (1) sell the ex-employee the policy as a fringe benefit, (2) transfer the policy to another key person or (3) surrender the policy for its cash value.

With the proper planning, you should be able to cover all the life insurance needs of your business. Consider this to be an important aspect of the business-planning process.

For more information on succession planning contact Terry Staley at 816-743-7700.

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