Commercial success often depends on the key people in your business, who likely bring unique skills and expertise to your team. According to Legal and General, 59% of businesses worry they would not survive for more than a year if one of their key team members became seriously sick or died. A key person insurance policy is a simple but effective way to prevent any potential losses your business may face if a key person dies or becomes critically ill.
What does key person insurance cover?
Key person insurance focuses on insurance for death, critical illness, or a combined policy covering both aspects. Your business can secure key person insurance for individuals crucial to the smooth operation of your organisation. The policy duration, such as five or ten years, is typically specified according to your specific needs. In some cases, key person insurance has an ‘income protection’ clause which covers the cost of temporary staff during the absence of the key person.
Who is a key person?
A key person would be anyone you consider vital to the day-to-day operations of your business, whose absence could lead to significant challenges and changes. While in many small businesses, the key person is the owner, it could also include anyone whose skills, knowledge, and experience directly impact revenue. It is essential to assess whether the business could carry on if that person was to pass away or face a serious illness, as well as considering both the operational impact and the cost associated with finding a replacement. Key people can include:
- Business owner
- Managing director
- CEO
- Operations director
- IT manager
- Computer specialist
- Chairperson.
What level of key person insurance do I need?
The required cover varies based on several factors, the most important being the key person’s annual salary. A typical guideline is to multiply the key person’s annual salary by 5 to work out the minimum protection level you need.
For example, if a director earns £150,000 annually, the key person insurance policy should ideally cover £750,000 or more in case of death or illness. The greater their impact on the business, the higher the cover should be.
We would recommend taking specific financial advice prior to taking any policy out.
What if the key person leaves or retires?
If a key person at your company leaves or retires before the key person protection policy ends, you have several options:
- Stop paying the premiums and the policy will then end.
- Continue paying the premiums until the policy ends, and your business will receive a capital sum in the event of a claim.
- Transfer the policy to the key person, making them the legal owner and allowing them to continue paying the premium.
If a partner is a key person and the policy is written in trust, it should revert to the key person.
What is a Cross-Option agreement?
A cross option agreement is put in place in case a shareholder at your company dies to give any surviving shareholders the option to buy back that person’s shares at market value or the deceased’s family to sell the shares to your remaining shareholders or company. This ensures the shares are held by the correct people following the death of an individual. Setting up a cross option agreement should maintain any claim to Business Property Relief on the deceased’s estate.
Tax implications of key person insurance
The tax implications for your company and the life insured can be intricate, involving considerations such as Income Tax, National Insurance and Capital Gains Tax (CGT). Seeking specialist advice from a private client expert is strongly recommended – contact us today to arrange an initial, cost-free discussion with one of our advisers.
Corporation Tax relief
Generally, if the proceeds of the policy are to cover the loss of trading income arising from the loss of the key person, they should qualify for Corporation Tax relief.
If the policy qualifies for tax relief, any payment to your company would be subject to Corporation Tax at the usual rate as a trading receipt.
If the policy is taken out for a different reason, such as buying the shares from the deceased, the premiums may not receive a deduction, but the proceeds are not taxable.
Structure
It is vital that the structure of the life insurance, any cross-option agreement, and the Articles of the company are drafted correctly and work with one another. Getting this wrong could result in unnecessary tax liabilities, money in the ‘wrong’ place, and possibly the shares owned by the wrong people.
How can we help?
Key person life insurance policies vary depending on the size and requirements of each company and understanding the intricacies of the clauses, as well as the tax implications, can be difficult without specialised knowledge.
Not seeking the right tax advice could be detrimental. Contact our expert private client team, so we can review policy details, any cross options agreements and advise on discrepancies that could cause later issues.