The Importance of Key Person Life Insurance
Life Insurance for Business Owners or Key Employees
When starting a new business there is a barrage of paperwork just to open the doors. Business owners quickly become aware that insurances of all types are very much part of the equation in the development and opening of a new business. No matter how busy you are with the basic operations of the company, you must take time out to implement strategies to keep your business financially sound. An important ingredient to this security is taking out “key person” life insurance (also known as Business Life Insurance).
Key person life insurance is a policy taken out on the life of the key executive, key employee or the business owner. Whether a company is large or small, all businesses depend on the key people to manage and keep the business running. A life insurance policy taken out on the key individuals makes economic sense for the company. The company, therefore, takes out a life insurance policy on the key individuals and pays for the life insurance premiums. The premiums can be tax deductible to the company so please check with your accountant. The monies that are paid to the company upon the death of the key employee or business owner allow that company the time to figure out what direction to take.
Survivors left to run the business can strategize as to how they can save the business. Will they hire a new management team in the death of the owner or if it is a key employee, will the owner find someone as qualified? Will they restructure operations altogether? Will they need to eventually sell off assets or sell the business? What debts need to be paid? No matter the case, the benefit paid out by the life insurance policy buys a company the much-needed time to make important decisions.
How Much Life Insurance do You Need for a Key Person?
Losing a key person in any business is a bit overwhelming and can bring on a series of different emotions—especially when considering how to replace them with someone new and just as experienced. With small firms, the founder usually holds the responsibility for keeping the books, managing employees, handling key customers and running all of the basic operations. Losing any key person leaves any company with much uncertainty and financial instability. Determining the value of a key employee in each circumstance is different. Companies must consider anticipated profits or losses; replacement costs and compensation plan for the new hire. These are some of the methods used in determining the loss of a key individual and the value placed on their service to the company. The best thing to do is to discuss your needs with your financial advisor so they can help you estimate the face value necessary to provide for the continuation of your company.
Sole Proprietorships
If you are a one-man operation and own a business with zero employees (family employees do not count) there is no need to buy a key person life insurance policy. Your assets will automatically transfer to your family upon your death provided you have a will or trust. However, if your family depends on the income from your business, it is advisable that you take out a personal life insurance policy to replace any lost income as a result of your death. This policy not only provides financial security for your family but the time for your surviving spouse to see if your business can be sold at a fair price and not as a fire sale. As a one-man operation, you work harder than most people. Every responsibility falls on your shoulders. Your goal is to provide for your family today and hopefully, to build a company of value for your future. Not everyone gets the chance to see his or her dreams and hard work come to fruition. Fate can suddenly step in and your family is left in the lurch. That is why life insurance is so important. It completes your dream and dreams you have for your family.
Partnerships
In most partnerships, all equity partners are considered to be key people. In this case, life insurance plays two separate roles. The first is to provide enough coverage to replace the key individual or the deceased partner. The second, and most important, is to provide enough money to buy out the surviving spouse’s interest in the partnership if one of the partner’s passes away. That is why it is so critical to draft a buy/sell agreement between all partners with an agreed upon value of the business. It is important to review the plan each year to take into account the growth of the business.
Corporations
Key person coverage is very important to both a closely held corporation and a large public company. Both entities continue even with a loss of a founder or major shareholder. Since both require an in-depth analysis, this discussion will be continued in another article.
Author: Sharon Taylor is a veteran financial writer and frequent contributor to EQUOTE Life Insurance