Most businesses employ at least one individual who is essential to the company’s success. This person may be a partner, majority stockholder or an employee with expertise that’s unmatched throughout the rest of the company. If this person’s exit from the company is planned, such as through retirement or a voluntary termination, then you can prepare for the loss and take the necessary precautions to minimize the impact.
However, if the departure is unplanned due to a death, disabling accident or sudden resignation, then the company is exposed to huge financial risks. If your business has employees that are vital to its success, consider key person life insurance to offset your risk. This coverage can protect your organization’s solvency in the event that you lose the key person or people without warning, and also the investments made by lenders and investors to the company.
How Does Key Person Life Insurance Work?
Here’s a general guide detailing how key person life insurance can protect businesses:
- The employer purchases key person life insurance on the key individual(s).
- The employer is the beneficiary of the policy, and applies for and owns the policy. If the key employee dies prematurely, the policy pays out to the employer.
- In most cases, IRS guidelines allow tax-free dollars from the policy to be put towards finding, hiring and training a replacement employee, compensation for lost business during the transition, and financing timely business transactions.
- Depending on the specific language in the policy, it can sometimes be transferred to a departing key employee as a retirement benefit.
- The policy can be used to buy out the key employee’s shares or interest in the company.
- Premiums are based on several factors, including the key employee’s age, physical condition and health history. The amount of coverage also affects the premium.
Key person life insurance has a number of advantages:
- Policies can be easily implemented and don’t require IRS approval. Your business only needs to prepare an annual report for the IRS.
- If all IRS guidelines are followed, the policy’s benefits may be paid to the company tax-free.
- Customers, creditors, lenders and stockholders have the assurance that the business has a continuation plan and coverage in place.
- There is flexibility in how the funds can be used.
In addition to proper coverage, create a business continuation plan that outlines how your business will function if you lose key employees.