Question

Why do businesses take up key man life insurance.

Answer 1

Key man insurance & its need:

This is also known as Key Person insurance. This is a life insurance policy purchased by the company on the key person’s name (life). In small or mid-sized businesses, this is usually the owner, founder or a key employee. The presence of this person is critical for the successful ongoing of the business. The company/business is the beneficiary under this policy.

The core idea of this kind of insurance is to protect & maintain the company in case of an early/untimely death of the key man. The proceeds of the insurance may buy the company some time to decide further strategy or find new person.

How does it work?

• The company purchases the life insurance policy in name of the key person(s).
• The premium is paid by the company itself and same is the beneficiary of the policy.
• The company can use the proceeds for basic expenses until it finds a replacement person or shuts down the operations. It also secures and settles loans, offer salary continuation, makes arrangements to the spouse of the deceased and funds executive’s compensation plans.
• The premium paid by the company is treated as business expenditure in books of accounts. And on death of the key man, it is shown as claims.

Insurable & Covered losses under key man insurance:

1. Losses related to the extended period - When a key person is unable to work, but is alive. The insurance covers expenses to offer temporary employee as his replacement, and finances for his recruitment and training expenses.
2. Insurance to protect profit - In some cases like balancing lost income from lost sales, losses from the delay/revocation of any business project or loss of specialized skills or knowledge.
3. Insurance to protect shareholders or partnership interests - In this case, the insurance allows shareholdings or partnership interests to be purchased by existing shareholders or partners.
4. Insurance for anyone involved in guaranteeing business loans or banking facilities - The value of insurance coverage is disposed to equal the value of the guarantee.

Tax Treatment of Key Man Life Insurance:

The cost of key man life insurance is not tax deductible in U.S. The insurance proceeds for policies owned by employers can be taxable if certain conditions are not met. Otherwise, the policy’s benefits would be paid to the company free of income tax. But, if the company receives the proceeds on maturity, then they may be taxable.

In case, the company decided to discontinue or sell the policy, it may have to pay taxes depending upon the company size, the amount of premium paid and cash value of the policy.

Benefits of Key man insurance:

• In case of death of a key man, the company gets money to manage the loss.
• Premiums paid are tax deductible in USA.
• No need to give advanced indication to the income tax authorities to claim deduction of insurance premium payment.
• The company can also raise loans on the policy from LIC except for the Term Plan.
• The policy also benefits key person’s immediate family from getting affected by the loss of member.
• The policy helps to improve the retention of key human resources of the business.