KEY PERSON INSURANCE: Definition and How It Works

key person insurance

Talented, devoted, and capable people are at the heart of every successful organization, but none of us knows what the future holds. According to research, 52 percent of businesses fear they will have to cease operations within a year of the death or critical illness of a key individual. A key-person insurance policy protects firms in the UK from the financial impact of the death of a key person, terminal illness (if the life expectancy is less than 12 months), or a specified critical illness (if chosen for an additional premium at the commencement).

The earnings of the policy are given directly to the business to assist replace the key person and offset any profit loss. The proceeds of the policy could assist your company in continuing to operate.

Who is a key person?

A key-person is somebody who is important to the day-to-day operation of your organization, such as a director, employee, or anyone whose talent, expertise, and experience effect revenue.

To put it another way, what duties might a key person have?

Consider whether any loans or financial commitments are dependent on that person, whether their absence might affect sales, or whether their departure would affect future planning, for example.

What is Key Person Insurance?’

Key person insurance, also known as “key man insurance,” refers to life insurance plans that cover businesses from the loss of a key individual—men or women—who is unable to work owing to a serious or terminal disease, or who has died during the term of the policy.

Simply put, ‘key person insurance’ protects a company from financial loss in the case of a key employee’s death. It’s about assuring your stakeholders that your company will live and prosper even if a key person dies or suffers from a certain serious illness.

What is the purpose of Key Person Life Insurance?

Key person insurance is intended to safeguard UK firms that rely on one, two, or more key personnel. With adequate key employee protection, a company will be able to fund sick leave and recruitment of new employees, as well as protect against any wider impact the loss of an employee may have on the business.

The loss of a key person, especially in a small corporation, can have disastrous effects on the organization. Key-person insurance is intended to assist a firm in surviving the loss of any person who is key to the operation of the business.

The proceeds of a key-person insurance policy can be used to cover expenses incurred as a result of the loss of a key employee until a suitable replacement candidate can be found.

In the worst-case situation, the cash can be used to pay off debts, distribute funds to investors, and shut down the business. Although it is a harsh reality in some cases, key-person insurance can protect a small business from bankruptcy.

Who is Eligible for Key person insurance?

If you own a business in the UK – for example, if you’re a limited company director – you can obtain key person insurance with the consent of the person who will be covered. You must have a financial tie with that person.

When is it a Good Idea to Get Key-person Insurance?

If your company is expanding, there is no right or wrong time to purchase key man or woman life insurance. A start-up company may be reliant on one or two persons who are critical to the company’s success, whereas a larger company may have more resources and the ability to replace key personnel with other personnel.

However, because established businesses have higher overheads, the loss of a single employee might have major ramifications for the organization. Every company is unique, but key employee insurance can provide a safety net for your company.

What Does Key Person Insurance Cover?

You can purchase key person policies that solely cover life insurance, only cover critical sickness, or both.

The policy is purchased to cover a certain term length. Premiums are usually guaranteed, and policies can typically be terminated at any time with no penalty.

The Advantages of Key Person Insurance

The biggest advantage of key person insurance is the peace of mind it can provide. If something were to happen to you or one of your company’s key employees, the impact on the firm would be greatly reduced due to the financial cushion provided by proper key man insurance.

If you take out a business loan in the UK, the bank may require you to purchase key person insurance to protect the loan. This gives the lender confidence that the loan will be repaid if the person or individuals most important to the company’s success unexpectedly die.

Some policies also allow you to include an option to protect against any loss of profits or the costs of replacing a lost employee.

Why Should I Consider Key Person Insurance?

It’s never pleasant to consider worst-case scenarios. However, the unfortunate reality is that the loss of a key person in your company could have a significant impact. Any business could suffer if a critical member of the team is absent, with sales and profits plummeting and greater responsibilities for the remaining workers.

Key Person Protection protects your company from the death, terminal, or critical illness of a key employee. It is intended to pay out a lump sum if the insured key person dies during the term of the policy. Thus, compensating for the loss of their skill, knowledge, experience, or leadership.

This money could be utilized to help the business recover considerably; for example, the revenues could be used to replace lost revenue or to find and hire a replacement.

Who needs key person protection?

Small businesses are substantially more likely to have one or two critically important personnel on whom the company relies for success. Key-person insurance is frequently disregarded by small firms, despite the fact that they require it the most.

Small businesses, for example, are more likely to have an involved founder. Without him, ideas and critical leadership would have been lost. The loss of such a person may harm the culture of a new company. The company may lack the strength to withstand the blow without a financial injection to help cushion the way to the stable, profitable ground.

Consequently, Key Person Protection can apply to any individual deemed vital to your organization. However, to assist you in considering your company’s needs, the following jobs are frequently covered by key person insurance:

  • Owner/founder
  • CEO Operations Director
  • Manager of Information Technology
  • Sales manager for web developers
  • Employees with a large network of contacts
  • Exceptional abilities

What is the process of Key Person Protection?

Key-person protection policy is a life insurance policy purchased to protect the life of a key person in your company. This includes critical illness coverage if desired. Because the policy is owned and paid for by the employer, any payout will be made to the employer.

If you purchase Key Person Protection to protect a key employee in your organization, you can submit a claim during the policy’s term in the following circumstances:

  • Individual’s death as a result of terminal illness (included – this is where life expectancy is less than 12 months)
  • A particular critical illness (if Critical Illness Cover is chosen at the outset for an extra cost)

The following terms and conditions apply. In order to insure someone as a key person, you must be able to demonstrate that your business would suffer a financial loss of earnings in their absence.

What does Key Person Protection help to safeguard?

Following the death of a key person, a payout from the policy could help with the following situations:

  • Profits that are lost.
  • Having to find and train a replacement
  • The loss of vital personal or business contacts as a result of a key person’s absence from a contract’s maintenance.
  • Loss of goodwill, which could have a direct impact on the company’s ability to raise cash or attract new investors.
  • Customers and vendors losing faith in the company
  • Currently outstanding loans

Cost of Key Person Insurance

The amount of insurance required by a company is determined by the size and nature of the firm, as well as the role of the key person. It’s worth getting quotations on policies worth $100,000, $250,000, $500,000, $750,000, and $1 million and comparing the costs.

The cost will also be determined by whether the company purchases a term or permanent life policy. Term life insurance is almost always much less expensive.

Furthermore, like with most other types of life insurance, the cost of the policy will fluctuate. This depending on the insured person’s age and overall health.

For a $500,000, 20-year term coverage on a healthy 50-year-old male, one big insurer would currently charge $107 each month. Increasing the coverage to $1 million would result in a monthly cost of $190.

How Does HMRC Tax Key Person Insurance?

Finally, how HMRC treats this insurance is determined by the plan’s purpose and who will receive the benefits. The rules can be complicated and appear arbitrary. This is because they are dependent on how the company intends to use the policy.

It’s important to note that if HMRC taxes the payout, you’ll need to gross up the benefit. This entails insuring yourself for a larger sum than you require. This way, after HMRC has deducted tax from the benefit, you are left with the correct payout.

Your adviser will gladly assist you with this, taking into account all applicable taxes.

Safeguarding Shareholders

Because the plan benefits someone other than the business, premiums are rarely eligible for corporation tax relief.

Meanwhile, a key person claim on a plan that covers shareholders is usually treated as a trading receipt. This means HMRC will tax the payout as well.

Employee Protection

HMRC typically considers such insurance policies to be a benefit to the business. As a result, premiums are generally tax-deductible.

However, the benefit is still considered a trading receipt (so HMRC will tax a payout).

Defending Business Loans

HMRC considers a key-person insurance policy on a business loan to be a benefit to the lender rather than the business. As a result, the company cannot deduct premiums from its corporate tax.

However, because the policy payout is meant to rebalance the company’s capital account, HMRC does not normally consider it a trading receipt. As a result, it is usually exempt from taxation.

The information provided above summarizes the widespread consensus on how HMRC taxes keyman insurance. However, we strongly advise you to consult with your accountant and the local tax inspectorate about your individual case.

In Summary,

According to research, 54 percent of small business owners do not have appropriate insurance in place to protect their organization from the unexpected loss of a key employee; 20 percent of business owners had no idea key person insurance existed.

Despite this, studies show that 46 percent of UK businesses without insurance would be forced to close their doors immediately if a key person died or was unable to work due to illness or accident.

Key person insurance prevents firms in the UK from losing money if an employee gets terminally or critically sick, or dies. The funds can be utilized to identify a suitable substitute. Key person insurance can help a company stay in business.

Key Person Insurance FAQs

What is the main use for key employee insurance?

The goal of key employee insurance is to assist a small business in the event of the death or disability of the owner or a key employee.

Who can get key man insurance?

Keyman insurance is a sort of insurance coverage designed particularly for small enterprises. These plans are intended to recompense the company if a key person dies or gets handicapped and is unable to perform their duties.

How does key person life insurance work?

The firm owns the policy, pays the premiums, and is the beneficiary of a key person life insurance policy. If a key person dies, the company receives a death benefit. This money might be used to help a company replace lost revenue while they look for a replacement.

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The firm owns the policy, pays the premiums, and is the beneficiary of a key person life insurance policy. If a key person dies, the company receives a death benefit. This money might be used to help a company replace lost revenue while they look for a replacement.

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