What are the Important Benefits of Key Person Insurance?
- Key man insurance plans can ensure that your company doesn’t have to close down or file for bankruptcy when an important employee or a few important employees cannot continue at their designated posts. This type of insurance plan ensures that businesses can continue operations and can survive even when key employees quit, are ill, disabled or pass away. While key man insurance is a must for larger companies with a principal shareholder or important executives, this type of insurance plan is crucial for the survival of small and medium businesses. Sole proprietors do not necessarily have to take out a policy however; partnerships and small business owners must consider investing in a good plan to protect their company.
- Key man plans can ensure that the company gets the proceeds when a claim is filed and that these proceeds actually help the company in various ways. For instance, the compensation payment given to the company by the insurer can be used for hiring new staff and training new staff in place of the policy holder. These funds can also be used to pay debts, loans, improve the credit rating of the company, get new funds from banks or make a good will payment to clients who are affected by the absence of the policy holder.
- Key man insurance plans can not only protect companies against loss of profit, but also loss of revenue and many other financial problems. Loss of profits can occur due to cancellations of projects, delayed projects and lost sales due to the absence of the key employee. This type of insurance plan can ensure that the company or the remaining partners have the required funds needed to purchase shares from the family of the policy holder if the policy holder has passed away.
- Depending on the company’s needs, it may be possible to either purchase just 1 insurance plan for 1 key employee or to purchase 5 or more plans for a few important employees. The size of the business and the financial needs of the business will determine the cover level. While standard plans offer a cover limit of $500,000, better plans with flexible terms and better benefits can offer a compensation payout of up to $10 million.
How Long Do I Have to Wait for the Key Person Insurance Plan to Come into Effect?
- While insurers try their level best to accept applications in a week or two, at times it can take insurers up to 6 weeks to approve applications. If the policy holder is asked to take medical tests, blood tests or fill out a lengthy questionnaire regarding his medical history, then the insurer may take 4 – 6 weeks to approve of the application.
- Usually applications are not rejected; however additional terms may apply for policy holders who smoke and have pre-existing health conditions. Older buyers may also be considered as high risk buyers especially if they have one or more pre-existing health conditions, genetic conditions and smoke. High risk buyers may be asked to opt for a plan with higher premiums, exclusions or premium loading fees amongst other things.
- If the policy holder is a low risk buyer or if a company decides to purchase a policy that does not require medical checks and has a fast track application process, then the policy may come into effect in 2 weeks. It should be noted that many policies have a waiting period and if this waiting period is applicable on the purchased policy then the benefits may only be offered to the beneficiaries after the waiting period is over. The waiting period may range from 14 days to 2 years, buyers usually have the option to choose a policy with a standard waiting period of 30 – 60 days or opt for a policy with a flexible waiting period. Opting for a shorter waiting period and flexible terms will cost more than opting for a contract with a longer waiting period and rigid terms; however flexible plans have a list of benefits that standard policies do not offer.
What is a Business Partner Buy Sell Agreement and how does it Affect My Company?
- A succession agreement can prevent the estate from asking value of the business even while insurance benefits have not yet been paid to the beneficiaries. If you have not signed a succession agreement and if there is no provision for crediting or transferring the assets to the remaining business owners when the policy holder passes away, then you may have to consider opting for a business partner buy sell agreement.
- If you opt for a business partner buy sell agreement, then you should make it a point to review this agreement at least once a year so that you can take into account changes that may arise periodically.
What are the Tax Implications of Key Person Insurance?
- If the insurer is giving the beneficiary a compensation payment towards a revenue purpose then that amount will be liable to be assessed for tax. Since this amount will be assessed for tax, the premiums will be tax deductible.
- If the insurer is giving the beneficiary a compensation payment towards a capital purpose then that amount is exempted from tax assessment and the premiums will not be tax deductible.
- Depending on the type of policy you purchase you may be able to file a claim for compensation that towards both a revenue purpose and a capital purpose.
- If in case a business is audited after they file a key person claim then the ATO will not only look at the stated purpose for the insurance in the records, but will also look at the use of the compensation payment.
- If the company has opted for trauma and TPD benefits, then capital gain taxes will be applicable. The benefits will be paid directly to the company and in most case, TPD and trauma payouts are not eligible to receive capital gain concessions.