While key-person life insurance policies vary, most pay a death benefit that can be used to cover the cost of recruiting a new employee and keeping the business stable during the transition.
How do you determine who needs to be covered and how much coverage you need? To answer those questions, think about the employee who creates significant revenue for your business and what it would mean to your business if that employee were to pass away.
That’s the purpose of key-person insurance. It’s like life insurance for your business. If you do lose a key employee, the policy will pay you for lost profits and, in doing so, buy you some time to replace the person and get your shop back on track.
Key-person insurance can also serve as a valuable employee retirement benefit when set up as a non-qualified, deferred compensation plan, which means that you promise the employee the cash value of the policy as it grows. The incentive to the employee is that he/she avoids taxes on that money until he withdraws it — hopefully when he’s in a lower tax bracket. If the employee dies before he retires, you use some of the benefits to pay his family and the remainder to recruit and train someone else.
Key-person insurance can also serve as an incentive to retain vital employees. Since you can divvy up benefits under the key person policy any way you want, you can legally offer part of any proceeds to the employee’s family in the event of his/her death. Therefore, you can incorporate the insurance into your employee benefits package and add one more layer to your employee retention plan.
There are a few pointers when buying key-person insurance. First, make sure that you buy the right amount, which your broker can help you determine. Secondly, don’t pay too much; look for a broker who will shop your policy around and get you the best deal.
When Your ‘Key Man’ is Your Business Partner
“Many automotive shops are partnerships, as is my own case, and we find the ‘Key Man’ to be our partner,” explains Chris Klinger, co-owner of Precision, Inc., a Honda/Acura specialist in Tucson, AZ, and long-time ImportCar magazine advisory board member.
“We didn’t entertain these types of expenses until we began to realize that we needed to begin to operate like the bigger company that we envisioned ourselves becoming,” Klinger continues.
Klinger and his business partner decided they needed to protect the continuity of their business they worked so hard to build, as well as each other’s family, in the event of the death of either one of them. And, they found an option to cover both of those bases.
“Life insurance combined with a Buy, Sell Agreement is the perfect combination to move seamlessly through this difficult situation, should it ever arise,” explains Klinger. “I find this to be the best use of life insurance for a small business.
“Our objective in cross-insuring one another with the additional use of a Buy, Sell Agreement was twofold: one, to ensure that the surviving partner retained full ownership of the business upon the other’s death, with no ‘new partners through inheritance’ entering the business entity; and, two, the life insurance proceeds would flow directly to the family who has suffered the loss. This is all made possible with a simple Buy, Sell Agreement drawn up by an attorney and signed by both partners.”
The Buy, Sell agreement gives the surviving partner the first right of refusal for the other party’s company stock. “Because the surviving partner is the beneficiary of the life insurance proceeds, he, in turn, uses this money to pay the family of the decendent for the company stock in which they inherited,” explains Klinger. “The use of a well-written Buy, Sell Agreement, combined with a good Key Man Life Policy for each partner, is the playbook that we will follow if the need ever arises. Removing these unknowns from your future gives you more opportunity to concentrate on what is really important — quality customer care and service, profitability and growth.”
Planning for the worst before you’re facing it is the best way to protect your business. Some owners may question if they can absorb the cost of another insurance policy. Consider the bigger question: “Can you afford not to?”
-Adapted from information provided by the National Federation of Independent Businesses.