You have a great group of employees working with you and your business is thriving. For many small-to-mid-sized businesses that success is due to key employee with both skills, experience and connections that would be difficult to replace.
But what if one of your personnel were injured and out of work for a while, or even worse, suppose they died unexpectedly? Would your business survive without this key person’s involvement in your operations?
If this were to happen, you’d likely immediately have to find and train a replacement, but getting the right person for the job would require a substantial amount of training and building on-the-job knowledge. During this transitional time, you could face losing business if you are unable to fulfill all of your orders or contractual obligations or if delivery time starts slowing.
Fortunately, there are two products that would provide your organization with additional funds to weather this uncertain time: key person life insurance and key person disability insurance.
Key person life insurance
Generally, your business purchases a life insurance policy on a key employee, pays the premiums and is the beneficiary in the event of the employee’s death. As the owner of the policy, the business may surrender it, borrow against it and use either the cash value or death benefits as the business sees fit.
However, coming up with a dollar value on a key employee’s economic worth can be challenging.
There are no specific rules or formulas to follow, but there are several guidelines that can help.
- The appropriate level of coverage might be the cost of recruiting and training an adequate replacement.
- Or, the insurance amount might be the key employee’s annual salary times the number of years a newly hired replacement might take to reach a similar skill level.
- Finally, you might consider the key employee’s value in terms of company profits. The level of insurance coverage might then be tied to any anticipated profit or loss.
Premiums for key employee life insurance are not a tax-deductible business expense for federal income tax purposes, since your business is the recipient of the benefits. For the most part, the death benefits your company receives as the beneficiary of the policy are not considered taxable income.
However, if your business is a C corporation, the death benefits may increase the corporation’s liability for the alternative minimum tax. You should consult a tax professional for information on your specific circumstances.
Key employee disability insurance
The death of a key employee isn’t the only threat to your business. What if a key employee is injured or becomes ill and is out of work for an extended period of time? Disability insurance on such a key employee is another way you can protect your business against any resultant financial loss.
A crucial part of key employee disability insurance policies is the definition of disability.
Typically, these policies define disability as the inability of the employee to perform his or her normal job duties due to injury or illness. As with life insurance, your business buys a disability insurance policy on the employee, pays the premiums, and is named as the beneficiary.
If the employee becomes disabled, the insurance coverage pays monthly disability benefits to your business. These benefits can equal a certain percentage of the key employee’s monthly salary, up to either a maximum monthly limit or 100% of their salary.
The benefits may be used to pay the operating expenses of the business and to cover the expense of finding a temporary or permanent replacement for the key employee.
The disability policies typically offer elimination periods (i.e. the waiting period between the disability and when the benefits begin) ranging from 30 to 365 days.
Depending on the policy, your business may receive benefits for 6 to 18 months, which would be long enough to allow the key employee to return to work or for the company to replace the key employee.
Depending on the type of coverage purchased, the premiums you pay for the key employee disability policy may or may not be a tax-deductible business expense. If the policy is considered business overhead expense insurance, then the premiums are a deductible expense.
While the business would be responsible for paying taxes on any disability benefits received, the business expenses the policy indirectly pays for would result in an offsetting deduction.
The takeaway
Planning ahead can help secure your company’s financial future. Key employee insurance can help assure families, employees, creditors, suppliers and customers that the future of the business is secure.
By purchasing life and disability insurance on the owner(s) and/or key employees, you can are ensuring peace of mind in the event that a tragedy should befall one of your most important personnel.