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The Benefits of Keyman Insurance for Employees and Employers

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The Benefits of Keyman Insurance for Employees and Employers

Is keyman insurance an employee benefit? The short answer is yes, but the benefits go beyond just the employee.

  • For Employers: Keyman insurance provides business protection and financial security in case a pivotal person is lost. It safeguards the company’s financial health by covering potential revenue losses and replacement costs.
  • For Employees: While primarily benefitting the employer, it indirectly benefits employees by ensuring business stability and giving peace of mind to their families through the coverage.

Keyman insurance, also known as key person insurance, is a must-have for businesses eager to protect their operations against the unexpected loss of vital personnel. This type of insurance doesn’t just represent a financial safety net for the company; it also serves as an important way to retain and reward top talent.

I’m Ryan McEachron, Chief Executive Officer of ISU Insurance Services ARMAC Agency. With years of experience advising businesses in Victorville, California, on their insurance needs, I can assure you that understanding whether is keyman insurance an employee benefit is crucial for ensuring both financial security and business continuity.

Keyman Insurance Benefits - is keyman insurance a employee benefit infographic comparison-2-items-casual

What is Keyman Insurance?

Keyman insurance, also known as key person insurance, is a life insurance policy that a company buys on a key individual whose knowledge, work, or overall contribution is essential to the business. This person could be the owner, a top executive, or anyone else whose sudden absence would significantly impact the company.

Definition

Keyman insurance is a life insurance policy taken out by a business on a key person within the company. The business pays the premiums and is the beneficiary of the policy. If the key person dies or becomes disabled, the insurance pays out a death benefit to the company.

Key Person

A key person is someone whose skills, knowledge, or leadership are vital to the company’s success. This could be the CEO, a top salesperson, or a specialist with unique skills. For instance, a small tech startup might take out keyman insurance on its lead developer, whose innovative coding is crucial to the company’s products.

Life Insurance Policy

Keyman insurance typically comes in two forms: term life insurance and permanent life insurance. Term life insurance covers the key person for a specific period, usually 10-40 years, and is less expensive. Permanent life insurance covers the key person for their entire life and can accumulate cash value over time, making it more costly.

Business Protection

The primary purpose of keyman insurance is to provide business protection. If a key person dies or becomes disabled, the insurance payout can be used to:

  • Cover the costs of finding and training a replacement
  • Offset lost profits
  • Pay off debts
  • Distribute money to investors
  • Provide severance benefits to employees

For example, if a small business owner passes away, the insurance can help the company stay afloat while a new leader is found and trained.

Financial Cushion

Keyman insurance offers a financial cushion that gives the company time to adjust to the loss of a key person. According to a study, the death of a founding entrepreneur can result in a 60% loss in sales. Having keyman insurance can mitigate such devastating financial impacts.

“Keyman insurance is not just a financial safety net; it’s a crucial element for business continuity and stability,” says Ryan McEachron, CEO of ISU Insurance Services ARMAC Agency.

Keyman insurance is a practical and strategic investment for businesses that heavily rely on specific individuals. It ensures that the company can survive and adapt in the face of unexpected and significant losses.

Keyman Insurance - is keyman insurance a employee benefit

Now that we understand what keyman insurance is, let’s explore why it is essential for businesses.

Why Keyman Insurance is Important for Businesses

Keyman insurance is a practical and strategic investment for businesses that heavily rely on specific individuals. It ensures that the company can survive and adapt in the face of unexpected and significant losses.

Business Continuity

When a key employee passes away or becomes disabled, the business can face severe disruptions. Keyman insurance provides a financial cushion that helps maintain operations during this turbulent period. This means the company can continue to function and meet its obligations without immediate financial strain.

Financial Protection

Keyman insurance offers a financial safety net. The payout can cover various expenses, including lost revenue and ongoing operational costs. This protection can prevent the business from sinking into debt or even bankruptcy due to the sudden loss of a key person.

Recruitment and Training Costs

Replacing a key employee involves significant costs. These include:

  • Recruitment expenses: Advertising, headhunter fees, and interview costs.
  • Training costs: Time and resources spent on training the new hire.

The insurance payout can cover these expenses, ensuring that the business can find and train a suitable replacement without financial difficulties.

Debt Repayment

Key employees often play a crucial role in managing business debts. In their absence, the company may struggle to meet its debt obligations. The funds from a keyman insurance policy can be used to service any debts for which the key person was responsible, safeguarding the company’s financial health.

Investor Payouts

Investors need assurance that their investment is protected. Keyman insurance provides this assurance by offering a contingency plan. In case of the loss of a key person, the insurance payout can be used to stabilize the business and keep investor confidence high.

“Having keyman insurance in place can improve confidence in your business,” notes a Forbes Advisor article. “It shows that you have a plan to handle unexpected events, which can be reassuring for investors and stakeholders.”

In summary, keyman insurance is not just about protecting the business; it’s about ensuring its continuity, financial stability, and growth even in the face of adversity.

Next, we’ll dive into whether keyman insurance can be considered an employee benefit.

Is Keyman Insurance an Employee Benefit?

Keyman insurance is primarily designed to protect the business, but it can also offer significant benefits to employees. Let’s break down how it works and its implications.

Employee Benefit

While keyman insurance is not a traditional employee benefit like health insurance or a retirement plan, it can indirectly benefit employees. When a business is financially protected, it can ensure job security for its employees. This insurance can help the company navigate the loss of a key person without having to make drastic cuts or layoffs.

Tax Implications

The tax treatment of keyman insurance can vary. Generally, the premiums paid for keyman insurance are not tax-deductible for the business. However, the death benefits received are usually tax-free, providing a financial cushion without additional tax burdens.

If the policy ownership is transferred to the employee, it may be considered taxable compensation by the IRS, potentially leading to a tax liability for the employee.

Financial Security

Keyman insurance provides a financial safety net for the business. In the event of the death or disability of a key employee, the payout can be used to cover lost revenue, hire and train new employees, and service any debts. This financial stability can be reassuring for all employees, knowing that the business has a plan to stay afloat even in challenging times.

Family Protection

In some cases, keyman insurance can also benefit the family of the deceased employee. The business may use the insurance payout to buy out the deceased person’s interest in the company, ensuring that the family receives a fair value for their share. This can provide financial security to the family during a difficult time.

Business Ownership

If the key employee has an ownership stake in the business, keyman insurance can be part of a buy-sell agreement. This ensures that the business can buy out the deceased owner’s shares, maintaining control within the company and providing fair compensation to the employee’s family.

While keyman insurance is not a direct employee benefit, it offers indirect advantages that contribute to the overall financial health and stability of the business, which in turn benefits all employees.

Next, we’ll explore the different types of keyman insurance policies available.

Types of Keyman Insurance Policies

Keyman insurance policies come in several forms, each with its own benefits and considerations. Understanding these options can help you choose the best coverage for your business needs.

Term Life Insurance

Term life insurance is the most common and cost-effective type of keyman insurance. It provides coverage for a specific period, usually between 10 to 40 years. If the key person passes away during this term, the business receives a death benefit.

  • Pros: Lower premiums, straightforward coverage.
  • Cons: No payout if the term expires before the key person’s death.

Permanent Life Insurance

Permanent life insurance covers the key person for their entire lifetime, as long as premiums are paid. This type of policy also includes a cash value component that grows over time and can be accessed for business needs.

  • Pros: Lifetime coverage, cash value accumulation.
  • Cons: Higher premiums compared to term life insurance.

Whole Life Insurance

A subset of permanent life insurance, whole life insurance provides lifelong coverage and includes a savings component that builds cash value. The business can borrow against this cash value if needed.

  • Pros: Guaranteed death benefit, cash value growth.
  • Cons: Higher premiums, complex policy structure.

Disability Insurance

Disability insurance can be added as a rider to a keyman life insurance policy. It provides financial protection if the key person becomes disabled and can no longer perform their duties.

  • Pros: Covers both death and disability, ensuring comprehensive protection.
  • Cons: Additional cost to the base policy.

Policy Options

When choosing a keyman insurance policy, consider the following options:

  • Convertible Policies: Some term life policies can be converted to permanent life insurance, offering flexibility as business needs change.
  • Riders: Additional features like disability income riders can be added to enhance coverage.
  • Custom Coverage Amounts: Policies can be tailored to cover specific financial risks, such as debt repayment or recruitment costs.

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Reviewing these options with an insurance agent can help you find the best fit for your business’s unique needs. Now, let’s dive into how to determine the right amount of keyman insurance coverage.

How to Determine the Right Amount of Keyman Insurance

Determining the right amount of keyman insurance is crucial for protecting your business. The coverage amount should reflect the potential financial impact of losing a key employee. Here’s how to calculate it:

Coverage Calculation Methods

  1. Multiple of Compensation:
    Multiply the key employee’s annual compensation by the number of years it would take for the company to recover from their loss. For example, if an employee earns $100,000 per year and you estimate a recovery period of 3 years, the coverage amount would be $300,000.

  2. Percentage of Revenue or Profits:
    Calculate the revenue or profit generated by the key employee and multiply it by the number of years it may take to replace them. If an employee contributes $200,000 annually and replacement takes 2 years, the coverage amount would be $400,000.

  3. Cost to Replace:
    Add up the costs of recruiting, hiring, and training a replacement, plus the loss of income during this process. If these costs total $150,000, that should be the coverage amount.

Revenue Impact

Consider how the loss of the key person will affect your revenue. If a key salesperson generates significant sales, their absence could drastically reduce income. Use historical sales data to estimate this impact.

Replacement Costs

Factor in the costs associated with finding and training a new employee. This includes advertising, recruitment fees, onboarding, and training. For highly specialized roles, these costs can be substantial.

Compensation Multiple

A common method is to multiply the employee’s compensation by a set number of years. This approach is straightforward and provides a quick estimate. For example, if you use a multiple of 5 for an employee earning $80,000 annually, the coverage would be $400,000.

Profit Percentage

Evaluate the percentage of profits the key employee is responsible for. Multiply this by the number of years you expect to be impacted. If an employee contributes 20% to annual profits of $500,000 and you estimate a 3-year impact, the coverage amount would be $300,000.

Example Calculation

Let’s say you have a key employee with the following details:
– Annual Salary: $100,000
– Contribution to Profits: 25% of $1,000,000
– Replacement Cost: $200,000
– Estimated Recovery Period: 3 years

Using the compensation multiple method (3 years):
[ \$100,000 \times 3 = \$300,000 ]

Using the profit percentage method:
[ 25\% \times \$1,000,000 \times 3 = \$750,000 ]

Using the replacement cost method:
[ \$200,000 ]

In this case, you might choose a coverage amount between $300,000 and $750,000, depending on your risk tolerance and financial strategy.

Final Thoughts

Accurately determining the right amount of keyman insurance ensures your business remains stable after losing a key employee. Discuss these methods with your insurance agent to tailor a policy that fits your specific needs. Next, we’ll explore the tax treatment of keyman insurance.

Tax Treatment of Keyman Insurance

Understanding the tax implications of keyman insurance is vital for making informed decisions. Let’s break it down:

Tax-Deductible Premiums

One common question is whether keyman insurance premiums are tax-deductible. Generally, they are not. The IRS considers these premiums a business expense, but since the business benefits from the policy, they can’t be deducted from taxable income. This holds true for most businesses.

After-Tax Dollars

Since premiums aren’t tax-deductible, they must be paid with after-tax dollars. This means the money used to pay for the policy has already been taxed. While this might sound like a disadvantage, the silver lining comes when the policy pays out.

Death Benefit Tax Implications

The death benefit from a keyman insurance policy is usually tax-free. When a key person dies, the insurance payout is generally received by the business without any income tax liability. This can provide significant financial relief during a challenging time.

However, there’s an important exception for C corporations.

C Corporation and Alternative Minimum Tax (AMT)

For C corporations, the death benefit must be included in the Alternative Minimum Tax (AMT) calculation. This means that while the benefit is still tax-free, it can impact the corporation’s AMT liability.

To comply with IRS regulations, businesses must ensure proper reporting and compliance to take full advantage of the financial protection offered by keyman insurance.

Limitations and Considerations of Keyman Insurance

Keyman insurance is a valuable tool, but it does have its limitations and considerations.

Policy Limitations

Keyman insurance primarily covers the loss of a key employee due to death or disability. It doesn’t cover situations where a key person decides to leave your company for another job or retires. This means that while the policy can provide financial support in the event of sudden loss, it won’t protect against all forms of employee turnover.

Non-Crucial Employees

You can’t purchase keyman insurance for every employee. This type of insurance is specifically designed for individuals who are crucial to the business’s operations and revenue generation. Employees who are not deemed critical to the company’s success are not eligible for keyman insurance coverage.

Independent Contractors

Keyman insurance is only applicable to employees, not independent contractors. If your business relies heavily on contractors, this insurance won’t cover their loss. This is important to consider if your business model depends on non-employee contributions.

Retirement

When a key employee retires, keyman insurance does not provide any financial benefit. The policy is designed to mitigate sudden and unexpected losses, not planned events like retirement. Therefore, businesses need to have other succession planning strategies in place to handle retirements.

Job Change

If a key employee leaves for another job, the policy does not offer any financial support. This underscores the importance of having strong retention strategies and contingency plans for replacing key personnel. Keyman insurance is not a catch-all solution for all types of employee departures.

Understanding these limitations helps businesses make more informed decisions about their insurance needs and ensures they are adequately prepared for various scenarios.

Frequently Asked Questions about Keyman Insurance

Who benefits from keyman insurance?

Keyman insurance provides significant benefits for both businesses and employees:

  • Business Protection: The primary beneficiary is the business. If a key person dies or becomes disabled, the insurance payout helps cover lost revenue, recruitment costs, training new employees, and even servicing debts. This financial cushion can be a lifeline for a company during tough times.

  • Financial Security: The business gets a financial safety net, which reduces stress and improves confidence in its stability. This is especially crucial for small businesses where one person might handle many critical roles.

  • Employee Families: In some cases, the insurance payout can be used to compensate the family of the deceased key person. This helps provide financial security to the family, ensuring they are not left in financial distress.

Can you write off keyman insurance?

Many people wonder if keyman insurance premiums are tax-deductible. According to IRS regulations, they are not. The IRS stipulates in section 1.264-1 that life insurance premiums are not considered ordinary and necessary business expenses. Therefore, businesses must pay for these premiums out-of-pocket.

However, there are tax implications to consider:

  • Death Benefit: The death benefit from a keyman policy is typically received tax-free if the premiums were paid with after-tax dollars.
  • Form 8925: For C corporations, there are specific reporting requirements related to corporate-owned life insurance. Businesses must file Form 8925 to report these policies.

What are the disadvantages of keyman insurance?

While keyman insurance offers many benefits, it also has some drawbacks:

  • Another Cost: Premiums for keyman insurance add to the business’s expenses. Although it provides valuable protection, it’s an additional cost that needs to be budgeted for.

  • Small Team Suitability: For very small businesses or startups, the cost of insuring multiple key persons can be prohibitive. Multiple policies may be required, each covering a single individual.

  • False Sense of Security: Relying solely on keyman insurance can create a false sense of security. It’s crucial to have a comprehensive risk management strategy, including succession planning and employee retention strategies.

  • Reliance on Key Person: Over-reliance on a single key person can be risky. If the business is too dependent on one individual, even with insurance, the loss can still be devastating. Diversifying responsibilities among multiple employees can mitigate this risk.

Understanding these FAQs helps businesses make informed decisions about keyman insurance and ensures they are adequately prepared for various scenarios.

Conclusion

In conclusion, keyman insurance is a crucial element of a comprehensive business insurance strategy. At ISU Armac, we understand the importance of financial security for both businesses and their employees. By offering keyman insurance, businesses can protect themselves from the financial fallout that may result from the loss of a key employee.

For businesses, keyman insurance provides a financial cushion that ensures continuity and stability. It can cover lost revenue, recruitment costs, and training expenses, helping the business to navigate the challenging period after losing a critical team member.

For employees, particularly those who are considered key persons, this insurance can be seen as a valuable employee benefit. It offers peace of mind knowing that their families will be financially protected in the event of their untimely passing. This added layer of security can also enhance employee retention and satisfaction, as it shows the business’s commitment to its employees’ well-being.

Located in Victorville, California, ISU Armac is dedicated to helping businesses find the right insurance solutions to meet their specific needs. Our expertise in keyman insurance, along with a wide array of other business insurance products, ensures that your business is well-protected and poised for long-term success.

Ready to protect your business and ensure its continuity? Contact us today to learn more about how we can help you secure the right key employee policy for your needs.

By partnering with ISU Armac, you can focus on what you do best—running your business—while we take care of your insurance needs.