It takes all of your employees to keep your business running. But what if something were to happen to one of your most essential employees — someone your business can’t do without … A “key person?”
A key person might be someone who is responsible for generating a major part of your sales or new business, or someone who has highly specialized skills or knowledge that your business depends on. It could be someone who oversees an important division, facility or process. Or it might be — and frequently is — one of the company’s owners or founders.
This key person is anyone whose death would threaten the existence of the business. Some companies have just one person like this, while others have several. If your company has one or more key people, you’ll want the peace of mind of knowing that you’re protected for unexpected situations, but how?
Life insurance can be used to ensure that if one of these key people died, your business would be able to continue to operate until you find a replacement or figure out a way to make up for the lost revenue.
Key Person Insurance and What It Covers
Key person insurance (formerly called “key man insurance”) is a life insurance policy that is owned by a business to insure a key employee. The company pays the premiums, and is also the beneficiary. If the key employee dies, the policy death benefit can be used to cover your essential business expenses such as salaries, overhead and loan payments, while the company gets back on its feet. It can also be used to help cover the cost of finding a replacement for the key person.
However if it’s just not possible for your business to continue without the key person, then the proceeds of the policy can be used to close up shop responsibly — pay off debts, distribute funds to investors, and provide severance pay to employees if possible.
Determining How Much (if Any) Coverage Is Needed
If your company is a sole proprietorship — that is, it’s just you, with no other employees — then this type of insurance may not make sense. Still, you should consider individual life insurance to benefit your family in the event of your death.
For other companies that have employees, key person insurance can make a lot of sense. To determine whether key person life insurance is right for your business, and how much coverage is needed, the first step is to assess which employees your company really couldn’t operate without. Then, go through the “what if” scenarios. If any one of those people were to die, what would it take for your company to recover?
Would clients or customers be permanently lost? How would the value of your business be affected? Could someone else in the company fill the key person’s shoes (and would you need to hire someone to fill that person’s old role?) or would you need to recruit someone new? How difficult would that be, and how much would it cost?
Our Key Employee Value calculator is a great way to start answering some of these questions.
Once you have identified the key person/people in your company you wish to insure, it is important that you give those employees written notice and obtain their written consent that meets IRS requirements to ensure that the company will receive the death benefits without adverse tax consequences. If your key person policy was issued after August 2006, it is important for you to determine if the requirements were met.
Is It Worth It?
As with any insurance product, there’s no guarantee that you’ll actually end up using the proceeds of the life insurance policy — and hopefully, you won’t have to. But there are some real benefits to having the coverage — just the peace of mind alone is a true benefit, but this isn’t the only one.
Many banks or other lenders want to know that you have key person insurance in place, so you’d be able to keep making payments on loans even if an essential employee dies. If your company has a board or shareholders, they may also want the assurance of knowing you have a plan in place.
Key person insurance can also be used as a source of funds if you buy a policy that accrues cash value. And in some cases, you can transfer ownership of the policy to the key person when he or she retires, as an extra benefit. Under certain circumstances, there may be tax implications. You should consult your tax or legal advisors.
Protect What You’ve Built
It takes countless hours and endless energy to build a successful business. Key person insurance helps ensure that in the event of a tragic loss, your business — and the people who count on it — could continue to thrive.
The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.Insurance products issued by Massachusetts Mutual Life Insurance Company (MassMutual) (Springfield, MA 01111-0001) and its subsidiaries, C.M. Life Insurance Company and MML Bay State Life Insurance Company (Enfield, CT 06082).