The loss of a key employee in a privately-held company can have a material negative impact for which life insurance can be an appropriate planning tool. Purchasing life insurance for your key employees – known as “key man” coverage – is a way to plan for the future and minimize the consequences of an unexpected event.
Why is it necessary to have life insurance on key personnel of the company?
As noted above, the unexpected death of a key person can have a traumatic effect on the operation of the business. You could experience a disruption to your ability to serve customers, there is often significant time involved with finding a replacement, and you may have to purchase stock from the owner’s estate. Therefore, using life insurance proceeds can be critical to the continued success of the company.
Life insurance is owned and payable to the company to support the key employee’s replacement. It provides funding for redemption obligations and helps meet liquidity needs, as well as paying death benefits and long-term replacement of lost income for the key employee’s family.
When should the company purchase life insurance for key personnel?
Consider purchasing insurance for any individual who is in a position that would significantly affect the company if an unexpected event occurs. It is important to look forward, as it is very hard to rectify a situation after it arises.
What is the tax treatment of life insurance proceeds to the company?
Generally, life insurance proceeds are received tax-free by the policy beneficiary. If the life insurance contract was issued after August 17, 2006, certain requirements must be met for a business to exclude the proceeds. These requirements must occur before the life insurance policy is issued. The proceeds of the life insurance policy may be used to help the business meet payroll and operating expenses while searching for replacement personnel or to pay death benefits to a designated beneficiary of the decedent. The costs incurred would be tax deductible to the employer.
Proper planning for future cash flow needs of the company and the families of the key employees is critical to ensuring your business can recover quickly from an unexpected loss. Life insurance can be a valuable tool, and there are many planning options available. However, the rules of the Internal Revenue Code and Regulations can be complex, so be sure to seek tax accounting, legal, and financial advice to structure these transactions properly.
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