Key Person Insurance: What It Is & Why You Need It for Your Small Business
If you’re a business owner or in another role that’s critical to your business, what would happen in the event of your untimely death? If your passing would have a devastating effect on the business, then you might want to consider key person insurance.
What is key person insurance?
In a small business, it’s often the owner that is personally responsible for doing all the things that keep it afloat: selling, providing the product or service, the bookkeeping, and so on. If that person passes away, the business is at risk.
Enter key person life insurance. This type of life insurance policy is available for a company to purchase on the life of an owner, founder, high ranking executive, or other employee (such as a top salesperson) whose activities are considered critical to the business.
In other words, this death benefit provides some financial padding to protect the business from the blow of losing an irreplaceable employee.
How it works
When you purchase a key person insurance policy, the business pays the premiums and is the beneficiary of key person life insurance.
Following the loss of a key employee, insurance proceeds can then be used to prolong the business in the short-term or take care of expenses needed to close the business down in an orderly manner. Other ways the proceeds can be used include, to pay off debts, pay employees’ severance, or distribute money to investors.
Premiums paid for a life insurance policy are not deductible on your business’ federal income taxes.
Here are some instances in which you might consider purchasing this kind of insurance coverage:
- Is the financial viability of the business linked to you (or the key employee’s) name, reputation or unique skills?
- Would the death of the key person threaten the company’s existence?
- Are you seeking a business loan and is collateral assignment (using a life insurance policy as collateral) a condition or requirement?
- Is your business a partnership in which each partner wants to be able to buy out the other’s shares in case one or the other passes unexpectedly?
If you’re thinking about this kind of coverage, look at who in your business is necessary for the business to thrive and determine how much coverage you need. If you have a wealth advisor who assists in small business planning and other financial matters relating to your business, they can help you understand the ins and outs of various policies and their costs.
Key person insurance isn’t necessary for every business. If your company is a sole proprietorship and employs just you and no employees, but you have a spouse, children or others who depend on your income, personal life insurance is perhaps the better way to go.
Talk to Ironwood Wealth Management about planning for your small business. There are a number of important financial concerns to manage when you have a business, and we are here to help. Contact us today.