Running a business can be difficult at the best of times, let alone at the worst of times. Here we outline some clever keyman insurance solutions to keep your business on track through tough times.
Events outside of the ordinary course of day to day activities can take the ‘wind out of the sails’ of a business. What happens when a key employee suffers an accident or illness resulting in disablement or death? What impact does the death of an owner have upon the business? With a little forward planning, the financial burden arising from these events can be reduced.
What is Keyman Insurance?
Key person insurance or keyman insurance are terms used to describe insurance against the loss of an individual who makes a significant contribution to the business. Events that trigger the loss of an individual need to be insured e.g. accident, illness, injury, disablement or death.
Keyman insurance can take the form of a life policy, TPD policy and/or a trauma policy. The lump sum benefit can be used to reduce the financial burden a business may suffer from the loss of a key person.
The taxation treatment of keyman insurance is based upon whether the proceeds are for a capital or revenue protection purpose. The purpose of insurance will impact the deductibility of premiums, and the receipt of proceeds.
Capital or Revenue protection keyman insurance?
Capital protection keyman insurance
Insurance may be identified for capital protection, when the loss of a key person would affect the business’ financial position (e.g. the balance sheet). Insurance proceeds could be used to repay loans, replace supplier arrangements or lost goodwill.
Generally where capital protection exists, the premiums are non-deductible, and the policy proceeds are not taxed as they are not included as income. However, capital gains tax (CGT) may apply.
Revenue protection keyman insurance
In contrast, insurance for revenue protection is taken out when the loss of a key person would impact the business’ financial performance (e.g. profit/loss statement). Specific examples may include taking out insurance to cover against recruitment costs, temporary replacement costs, training costs or bad debts.
Generally where revenue protection exists, the premiums are deductible and the policy proceeds are taxed as income. A deduction may be available where any policy proceeds are used to pay business operating expenses.
A keyman insurance case study
William runs a successful chemical manufacturing company, XYZ Manufacturing, which employs a certified industrial chemist, Karl, who is critical to the business’ core activities.
William would like to insure against Karl’s departure due to illness, disability or death. Karl’s loss would have a significant impact on the business, resulting in temporary replacement costs, recruitment costs and perhaps additional training for a replacement.
XYZ purchases a life, TPD and trauma policy on Karl’s life with the intention of using the policy proceeds to temporarily replace Karl while they attract a replacement industrial chemist.
In this instance, key person insurance would be for revenue protection, which means the insurance premiums would be deductible, and the policy proceeds would be taxed as ordinary income by XYZ.
Keyman insurance can reduce the stress imposed on businesses with the accident, illness, injury or death of a key person or business owner. Effective planning can provide a strategy that meets the business’ needs. Ineffective planning may deliver a poor strategy, resulting in further burden upon the business.