If a key employee dies or suffers a critical illness, your business could be seriously impacted. We explore how insurance can mitigate the risks.
At a glance
○ Small businesses often don’t have key person insurance
○ Firms can use the insurance to cover any business issues that result from individual’s absence
○Getting advice on the right cover at the right price, and on tax considerations, can help ensure continued business success
A lot of small businesses insure their premises, equipment and machinery. But strangely, they often don’t protect against the more important risk of key individuals dying or having serious health problems. Key person insurance addresses this critical issue by paying a cash sum if that happens.
A typical policy pays three to five years of that person’s salary if they die or have a critical illness. Firms can use insurance to cover any business issues that result from the individual’s absence. This can include lost revenue, but also covers cash flow and costs such as recruitment and training – buying you time to get the best possible replacement, which is essential to continuity and future success.
Who is a key person?
A key person is someone whose death, critical illness or disability would seriously impact business profits.
A key person does not be a director or shareholder. It might not even be an employee – for example, it could be a contractor or anyone else the business has an insurable interest in.
Key person insurance is only directly available to limited companies – not the self-employed. Partnerships can use key person cover, but that requires a more complicated arrangement involving trusts.
Also, if the business is unlikely to continue without that individual – for example, where it’s just one employee or a husband-and-wife team – key person cover would not make sense. Any claim is paid to the business, but there may be no business to pay to. So personal life insurance and critical illness policies are more suitable.
How to calculate key person insurance
Insurers have different quoting methods for key person insurance premiums and benefits. The most common is based on salary multiples, but some use more complicated formulae. To calculate a more specific or accurate amount, you need advice to help you establish the actual value that could be lost.
How easy would it be to replace the individual? How long might it take? What profit might you lose in the short term? Do you have succession plans and junior staff members ready to step into the role? Or would you need to hire an interim replacement, or outsource a specialized part of the role? What health issues does the individual have? How long do you want the contract to last?
Tax implications for key person insurance
The tax rules on key person insurance are complex. The business can claim a corporation tax deduction on premiums if it meets certain criteria.
Payouts are generally treated as business revenue, which is taxable, but this is not always the case. If it’s taxable, you will need to gross up the payout to make sure the net figure still meets your needs. We can help ensure you take the right approach from a tax perspective.
How we can help
When deciding who to insure and for how much, talk to us. We can help you get the right cover at the right price to ensure your continued business success and advise you on the tax considerations.
The levels and bases of taxation and reliefs from taxation can change at any time and are dependent on individual circumstances.