What is Key Person Insurance?
Key person insurance is a life insurance policy that a business takes out on its most valuable employee or employees. A policy can also include a rider for disability coverage to help if a key employee is disabled.
Key person insurance helps safeguard a small business if an imperative employee dies or becomes disabled.
What is a Key Person?
For key person insurance, a business focuses on the employees it considers indispensable. A key person is often the business owner but could also be someone who has a highly specialized role or is responsible for bringing in a large share of sales. Such employees can be extremely difficult, and expensive, to replace, and their loss would resonate throughout the entire business. Sole proprietors may also opt for key person insurance to protect family members who will inherit their business.
Under a key person life insurance policy, the business owns the policy, pays the premiums and is the beneficiary. If a key person dies, the business then collects a death benefit. That money can be used to help a business replace lost revenue as they search for a replacement.
Keep in mind that some lenders mandate that businesses purchase key person insurance to receive financing.
How Much Coverage is Necessary to Insure a Key Person?
There’s no exact formula for determining how much coverage is necessary to insure a key person, but thinking about how much it would cost to replace this individual is a good place to start. When coming up with this figure, it is helpful to consider the percentage of the key person’s contribution to the company’s bottom line, as well as his or her current salary, which companies will generally multiply by a factor of five to seven.
You will need to choose between a term or permanent insurance policy, depending on what makes the most sense for your business.
Under a term policy, the business receives a death benefit if the key employee dies while the policy is in force. Premiums are level for the initial time period – which is generally 10, 20 or 30 years, depending on the policy. A permanent insurance policy also pays a death benefit if the key person dies while the policy is in force, but the policy offers a cash value fund that the business can take advantage of.
Key person insurance can help provide a financial lifeline for your business at the loss of a key employee. Century Insurance can help you understand the coverage your business needs, and the options you have to protect it.
What are Buy-Sell Agreements?
A buy-sell agreement is a binding contract that will govern what happens when a triggering event occurs. Additionally, it can contain the terms and fair market value for a buyout of the business interest. As a funding tool for the buy-sell agreement, life insurance provides unique advantages, including immediate cash availability to purchase a deceased owner’s interest.
How Does a Buy-Sell Agreement Work?
- In a cross-purchase plan, each business owner purchases a life insurance policy on each of the other owners.
- Each business owner will pay the premium and will be the owner and beneficiary of the policy written on the partner’s life.
- When there are multiple owners, other planning techniques are available to reduce the number of policies needed for a cross-purchase agreement, such as a buy-sell partnership and a trusteed cross-purchase.
- In an entity purchase or stock redemption plan, each owner enters into an agreement with the business for the sale of their respective interests in the business.
- As a part of this agreement, the business will purchase separate life insurance contract on the lives of the owners. The business will pay the premiums and will be the owner and beneficiary.
How Can a Buy-Sell Agreement Help a Business?
- A buy-sell agreement helps establish the value of the business and identifies the purchaser of the business interest.
- The buy-sell agreement helps the owners maintain continuity for their customers, employees and creditors
- The owners have the assurance that a deceased or disabled owner’s share of the business will not transfer to an unsuitable owner.
- When the buy-sell agreement is funded by life insurance, cash is available to purchase an owner’s interest, alleviating the strain of having to wait to get paid.
How Can a Buy-Sell Agreement Help Business Owners?
- A buy-sell agreement establishes a ready market for the business interest.
- A buy-sell agreement allows for the orderly transfer of ownership.
- Proceeds received from the buy-out may provide estate liquidity to offset debt, expenses and taxes. It may also provide a valuable income stream for loved ones.