Advanced planning

Key person life insurance

Your clients know that their employees help make their business a successful, thriving enterprise. In fact, they may identify some employees as “key” to the organization’s ongoing success. These individuals possess unique skills, expertise, decision-making power and vision. Key person life insurance is an important protection strategy.

What is key person life insurance?

Key person insurance is a life insurance policy purchased by, owned by and payable to a business. A key person life insurance policy protects against business losses as a result of the death of a key person. When permanent life insurance is used, the business can access accumulated cash values in the policy as a source of capital to offset business expenses, take advantage of expansion opportunities, or to create fringe benefits for key employees.

If the insured employee passes away, the policy’s death benefit provides capital to help the company continue. Unlike other sources of capital – such as a sinking fund, a loan, or company earnings – life insurance provides liquidity precisely when the need arises: upon the death of a key person. Further, disability riders are available that can waive premium payments in the event of the insured’s qualifying disability.

How key person life insurance protects your client’s company

Your client’s business pays the life insurance policy premiums and is typically the owner and beneficiary of the policy. As owner of the policy, the business may access cash values, typically via loans, during the key person’s lifetime. When the key person dies, life insurance proceeds, minus any loan amounts, are paid to the business and can be used to offset losses. Alternatively, upon the key person’s retirement, the company may decide to sell or bonus the policy to the insured, surrender the policy or simply keep it in force.

The benefits

• The business can receive an income tax-free death benefit upon death of the key person, thereby providing liquidity precisely when the need arises.
• When permanent life insurance is used, the business (as owner of the policy) has access to cash values during the life of the insured.
• Accumulated cash values in permanent life insurance can be used as a source of capital for business expenses, to create fringe benefits, and/or provide a rainy-day fund for the business.
• Optional disability riders are available that waive premiums in the event of the insured’s total disability.
• Accumulated earnings tax will not accrue if life insurance is purchased to reasonably compensate the business for a loss.

Additional considerations

• The employee should be a key person in the business. This includes directors, executives, or employees with unique skills and talents.
• To help ensure that death benefits are received income tax-free, the business must obtain notice and consent from the insured employee, prior to issuance of the policy.
• The company should adopt a board resolution authorizing the policy and documenting the need for key person protection.
• Premiums paid for key person life insurance are not a deductible business expense.