Key Employee Life and Disability Insurance

Your key employees are those special people with such unique skills and talents that they contribute greatly to the financial success of your business. If a key employee were disabled and out of work, or were to die, your business would suffer a financial loss. Here are some possibilities:

• While the employee is out of work, the revenue that he or she generates may substantially decrease
• You’ll incur unexpected expenses recruiting and training a temporary or permanent replacement
• Less capable or inexperienced employees trying to fill in can make mistakes or cause delays that cost you money
• If a key person dies, a business loan may come due
• Customers or even other employees may look elsewhere, concerned for the future of the business after the loss of a key employee

Key employee life and disability insurance policies can help soften the impact of these blows. Generally speaking, these policies are sold to small or medium-size businesses; it’s in those operations that a single person can make the most difference to the bottom line. If you own a large company that’s better able to absorb the financial losses caused by losing a key employee, you may have difficulty buying the coverage you desire.

If death does you part–key employee life insurance

Typically, 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.

In determining how much insurance you’ll need, putting a dollar value on a key employee’s economic worth may be difficult. Although there are no rules or formulas to follow, several possible methods to determine the insurance amount may be used. The appropriate level of coverage might be the cost of recruiting and training an adequate replacement. Alternatively, 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 loss.

The premiums you pay 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. Prior to August 16, 2006, the death benefits your company receives as the beneficiary of the policy aren’t considered to be taxable income. But for policies issued after August 16, 2006, proceeds from a life insurance policy insuring the life of an employee and payable to the employer-policy owner may be subject to income tax, unless an exception applies. Also, 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 circumstances.