Business Insurance Protection
Key Man Policy
Key person insurance is simply life insurance on the key person in a business. In a small business, this is usually the owner, the founders or perhaps a key employee or two. These are the people who are crucial to a business–the ones whose absence would sink the company. You definitely need to consider key person insurance on those people.
Here’s how key person insurance works: A company purchases a life insurance policy on its key employee(s), pays the premiums and is the beneficiary of the policy. If that person unexpectedly dies, the company receives the insurance payoff. The reason this coverage is important is because the death of a key person in a small company can cause the immediate death of that company. The purpose of key person insurance is to help the company survive the blow of losing the person who makes the business work.
The company can use the insurance proceeds for expenses until it can find a replacement person, or, if necessary, pay off debts, distribute money to investors, pay severance to employees and close the business down in an orderly manner. In a tragic situation, key person insurance gives the company some options other than immediate bankruptcy.
Executive Bonus Plans
Many businesses choose to pay their bonuses in cash, but you might consider offering your key people other choices. One option could involve using part – or all – of their bonus to purchase life insurance.
Here’s how it works: Under the executive bonus plan, the employee purchases (and owns) an index universal life (IUL) insurance policy. The employer then uses the bonus to pay the entire policy premium directly to the insurance company.
The premium payment is reported in box 1 on the employee’s W-2 statement. (This compensation is subject to Social Security (FICA) taxes if the employee’s pay is below the FICA wage base, as well as Federal Unemployment tax.) Because the bonus is reported as compensation, you can deduct it as a business expense to the extent permitted under Section 162 (there are limits to deduction of compensation for certain executives). Since life insurance is an underwritten product, any strategy that includes it is contingent on the health underwriting of the insured and, in some cases, financial underwriting.
Executive bonus plans help your employees feel valued and appreciated. If the executive bonus is used to purchase life insurance for your employee, it can also offer other tangible benefits by:
- Providing an income-tax-free death benefit for their beneficiaries
- Becoming a potential source of tax-free supplemental retirement income through loans or withdrawals from any available cash value.
Executive bonus plans can also benefit you. In addition to the tax advantages described above, an executive bonus plan can help your business attract and keep top talent. And remember that, as a business owner, you can set up an executive bonus plan for yourself, too – so you can enjoy the same tangible benefits as your employees.