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Life Insurance for a Key Person
In the following article we will discuss key-man life insurance: what is it, who needs it, and how to find the best price available. We will also briefly touch on the potential tax ramifications to a business that receives proceeds from key man insurance.
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Key-Man Business Life Insurance
What is Key Man Life Insurance?
Key man (key person, key employee) business life insurance is insurance taken out by a business that covers a person or persons within the business whose loss to the business would create a substantial financial hardship. Basically, whoever is vital to the survival of the business can be a key man or women. The business identifies the key man, life insurance is bought by the business on the key person, the business pays the premiums and if the key employee dies, the proceeds are paid out to the key man life insurance beneficiary—the business.
Key Man Life Insurance: Is your Business Protected?
Identifying Key Employees
Key employee business life insurance should focus on three main categories: (1) Business continuity or survival, (2) impossible or difficult to replace, (3) financing for an SBA or bank loan.
- Business continuity or survival: Key employee insurance should be used for any person in the business organization whose sudden death would threaten the continuity or survival of the business. Key Person Insurance gives creditors peace of mind knowing if the key employee dies the business will not.
- Impossible or difficult to replace: Key person life insurance should be used for any employee whose unexpected death would make it impossible or difficult for the business to find a replacement.
- Financing for an SBA or bank loan: Key man life insurance will typically be required on any owner of a business who desires to take out a SBA or bank loan.
Examples of Key Employees would be:
- An owner, especially if the loss affects the short or long term viability of the business such as adversely affecting the company’s standing with creditors or the company’s ability to secure financing.
- A top salesperson especially if the salesperson has become the “go-to guy” for many of the company’s top customers and brings in a sizable percent of the income of the business.
- A scientist or software engineer who developed the company’s intellectual property would most definitely be considered a candidate for key-man insurance.
Determining the amount of key man life insurance
There are various ways to determine the amount of key-person insurance the business needs. Ultimately, the amount that should be decided on is an amount that the business can afford without taking a toll on other areas of the business. Three areas to consider are the cost of replacement, multiple of income, and percentage of business income.
Cost of replacement: What it would cost the business to replace the key employee? Factors to consider would be the time it takes to find a replacement, training, and bringing the new employee up to speed. All the while that it takes to find a replacement the business would be losing revenue due to the loss of the key employee, so the revenue loss should also be factored in. The typical number used is around ten times the key person’s earnings.
Multiple of salary/income: this is an easy valuation method but fails to take much, if anything specific to the key-employee or business, into account. Simply take the current key employees income and multiply it by a factor of five to ten times.
Percentage of business income: What percentage does the key person contribute to the overall income of the business? Once the percentage of the business income is determined, that number should be multiplied by how long it would take to find someone to fill that key person’s shoes, typically 1-3 years.
A quick way to calculate a key person’s value would be to determine the employees percentage contribution to the net or gross profits of the business. Next, multiply that number by 2 years for gross profit percentage and 5 years for net profit percentage.
For example, if a key employee contributes 10% to the company’s net profit and the company’s net profits are $1,000,000 a year, that key employee contributes $100,000 a year. Therefore, a $500,000 key man life insurance policy would be needed [(10% X $1,000,000) X 5 years] using the net profit percentage.
General Underwriting Requirements for Key Person Insurance
- Typically an underwriter will allow face amounts between 5-10X earned income.
- Bonuses may also be included.
- Some companies require that the bonus is paid regularly as part of a company bonus plan.
- Also, if the key person has an ownership interest in the company, the appropriate percentage of company net income can be added to his or her income.
- An Employer Owned Life Insurance Acknowledgement and Consent form needs to be signed by the employee before coverage goes into effect.
- Note: Some states have specific requirements for an employee to qualify as a key person.
A life insurance company will inquire into how the business determined the insurance amount sought. Underwriters of key man insurance typically want to know the key employee’s:
- Business type,
- role in the business,
- specialized skill, and
Business Type: S Corp, LLC, C Corp, Sole Proprietorship, etc…
Income: insurance companies will use the key man’s income level to help determine how much coverage to offer.
Role in the business: The key man’s role in the business is important because not just anyone is considered valuable enough to be termed “key-man.”
Specialized skill: similar to the role in the business above, the specialized skill held by a key man helps shed light on whether or not the employee is truly a key man.
Experience: the more experienced an employee the more vital to the organization he or she becomes. Therefore, the experience level helps life insurance carriers determine how valuable a key employee truly is.
What type of Key Man Life Insurance to choose?
Deciding on the right type of coverage is not always an easy task. Sometimes it just makes sense to choose whole life over term life. However, each unique scenario requires professionals adept at assessing the pros and cons of whole life versus term life.
For more advanced key man planning, please visit our article discussing the infinite banking concept.
Term Life Insurance
- The lowest cost life insurance will be term life. Term life comes in various term lengths and the premium is fixed for the duration of the term. Term lengths typically range from 10-30 years, although 1 and 5 year terms are available.
- We also represent a company that will offer up to $1,000,000 no exam coverage for a key employee. Therefore, if you need coverage and the key employee does not wish to take an exam, this may be an option.
Permanent Life Insurance
Permanent life insurance comes in two main flavors: Whole and Universal Life
Whole life insurance builds cash value and lasts the lifetime of the insured. One of the benefits of cash value life insurance is the ability to access the funds via tax free policy loans. This can add liquidity to your business when you need it most. It can also add incentives for your key person to stay with your company until his or her policy has fully vested.
Universal Life includes Guaranteed, Indexed and Variable.
- Guaranteed Universal Life typically is guaranteed to last the rest of your life. It does build some cash value but at a much slower pace than whole or indexed universal life.
- Indexed Universal Life Insurance might be a good option since it retains cash value. The cash value might add a further incentive to keeping your key employee around. Further, if the key employee does leave, the policy can be sold off to a third party as a life settlement. The older the key man the better price the company can receive on the now no longer needed coverage.
What type of coverage is best for key person business insurance?
There really is no one size fits all answer or policy. Each product has unique features and benefits. Additionally, some include important life insurance riders, such as disability, critical illness, chronic illness and terminal illness riders. Give our experts a call today to talk over your options. We will help guide you to the right product that is a fit for you and your business needs.
Sample Key Man Life Insurance Rates
Monthly quotes are based on a preferred plus 50 year old male; rates are for informational purposes and must be qualified for.
|Face Amount||10 Year||20 Year||30 Year||GUL to 110|
Monthly quotes are based on a preferred plus 50 year old female; rates are for informational purposes and must be qualified for.
|Face Amount||10 Year||20 Year||30 Year||GUL to 110|
You can also view our sample life insurance rates by age chart for more.
How Long of a Term do I need for Key Man Life Insurance?
Usually the term length should be tied to a specific date in the future, such as retirement. For example, if a key person is currently 45 years old and the expected retirement for that employee is age 65, then 20 year term life insurance would be appropriate.
Once again, other types of life insurance, such as whole or universal life, might be more beneficial for providing an incentive to the key employee if the cash value will be made available to the key man.
Are Key person insurance premiums tax deductible?
Key man insurance premiums are not tax deductible. See IRC 26 U.S. Code § 264 (a) General rule: No deduction shall be allowed for— (1) Premiums on any life insurance policy…if the taxpayer is directly or indirectly a beneficiary under the policy or contract.
Are proceeds from Key Man Life Insurance taxable?
The proceeds to the business from the key person life insurance are considered income and the business will be taxed unless the Notice and Consent requirements of Section 101(j) are met.
See IRC 101 § (j) Treatment of certain employer-owned life insurance contracts:
(4) Notice and consent requirements
The notice and consent requirements…are met if, before the issuance of the contract:
- the employee is notified in writing that the applicable policyholder intends to insure the employee’s life and the maximum face amount for which the employee could be insured at the time the contract was issued,
- the employee provides written consent to being insured under the contract and that such coverage may continue after the insured terminates employment, and
- the employee is informed in writing that an applicable policyholder will be a beneficiary of any proceeds payable upon the death of the employee.
In addition, form 8925 must be included with the employer’s annual income tax return. The following information is required:
- The number of employees at the end of the year.
- The number of employees who are insured at the end of the year under employer-owned life insurance contracts.
- The total amount of life insurance in force at the end of the year under these contracts.
- The name, address, and taxpayer identification number of the employer and the type of business in which the employer is engaged.
- Whether the employer has a valid consent for each insured employee, and if not, the number of insured employees for whom a consent was not obtained
How we can help you get the lowest rates on key man life insurance
TermLife2Go specializes in finding the best life insurance rates available for our clients by focusing on each unique niche of the various life insurance carriers in the marketplace. We stay on top of the latest trends and know who to go to for various health and lifestyle conditions. We work with the top 10 best life insurance companies in the U.S. and have an intimate knowledge of the various nuances of each company. We also have our finger on the pulse of the top no exam life insurance companies available. Either way, it is important to choose the right company and that is where we help our clients save thousands on life insurance.
For example, you may want to apply for diabetic life insurance. The key is to apply with the most diabetic friendly carrier available. And who that may be can, and often does, change. The difference between companies that have looser underwriting guidelines and those who have standard guidelines can be substantial as it can make a big difference between the premium payment or if the insurance is even approved.
Therefore, if you desire the lowest premiums for your insurance, give us a shot at saving you thousands over the life of your insurance policy. We have helped many business owners secure affordable key man life insurance and we can help you as well. We are here to serve!
We do not favor one life insurance company over another. Instead, we find out what you need and then we recommend the lowest priced, best life insurance company to meet your specific need. Therefore, if price matters to you, give us a chance to earn your business.
For a free life insurance consultation and for free quotes from dozens of top rated life insurance companies, please call us today or enter your information into our free quote engine.
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This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting, tax, or specific advice to your situation.