Many businesses rely on one or more key people for their continued operation and success. How can you protect your business if one of these key people dies or becomes disabled? Having the right insurance in place can protect your business from the sudden loss of a key person in a number of ways. Not having the right protection could place your business in great difficulty, and could even prove fatal.
Who is a ‘key person’?
A key person is any person who provides your business with significant economic gain or benefit through their continued association. Key persons play an important part in generating the revenue for the business, and/or obtaining business loans providing funds to repay outstanding loans. The following are some examples of key people:
- Managing Director
- Director who is guarantor for a number of loans
- Employee with a particular technical expertise
- Senior sales manager
What if a key person dies or becomes incapacitated?
If a key person can no longer work, the business would normally need to find and train a replacement. During this time, the revenue (sales) of the business could significantly reduce, putting further stress on the business and its ability to meet its everyday expenses.
The loss of a key person could also jeopardise any outstanding loans held by the business. For example, on the death of one of the business principals, a lender may call in a loan if it is not satisfied that it can still be repaid. Such an event could force the business to sell its assets in order to repay the loan at short notice.
How to use insurance to cover key person risk?
Insurance for key person purposes can protect your business if one of your key people dies or becomes unable to work. The insurance proceeds could be used to replace lost revenue or to protect the assets of the business by providing funds to repay outstanding loans.
What can happen without life insurance for the key person?
A business could face significant hardship, or even closure, on the unexpected loss of one of its key people. Insurance can help minimise this risk.
Who should own the insurance policy?
Insurance to cover key person for revenue purposes is generally held in the name of the business. If an insured person dies or becomes permanently disabled, the business will use the insurance proceeds to replace lost income or hire and train a replacement. If the purpose of the insurance is to repay a loan, the policy owner will usually be the entity, which holds the loan. This will often be the business itself.
Are the insurance premiums deductible to the business?
The purpose of insuring the key person will determine whether the premiums are tax deductible and how the proceeds are taxed.
As a general rule, where the purpose of the insurance is to protect the revenue of the business, such as by replacing lost sales, the premiums will be tax deductible and the insurance proceeds will be assessed as income.
Alternatively, where the purpose of the insurance is to protect the assets of the business, such as to pay down an outstanding loan, the premiums will not generally be tax deductible and the proceeds will not be assessed as income. In some cases however, capital gains tax may apply. You should always speak to your accountant or registered tax agent about the tax treatment of insurance policies.
The importance of financial advice
Insurance for a key person can be complex and the needs of each business will be different. Your financial adviser can give you advice about the right type and level of cover for the key person, tailored to your business needs. You should also seek professional tax advice.
Interested in speaking with a financial adviser?
Contact Capital Advice Partners on 02 8920 3488 or use the form on the right today.