It is a fact known to many business owners that a key part of their success walks out of the door at the end of each workday. Employee retention strategies address this concern, meeting employees’ wandering eyes with various kinds of compensation, but profit-sharing can’t address every reality of life – like death or disability.
For that, there is key person insurance.
At first glance, key person insurance can seem uncomfortably calculating. It’s a life insurance policy on a key employee intended to cushion the business’s revenue loss following that employee’s death or incapacitation. However, it serves an important purpose of protecting the business – and all the people who rely on it – when someone irreplaceable suddenly needs to be replaced.
Key person insurance is highly customizable, and while primarily focused on death and disability, it can help business owners deal with the other D risk: departures. Unfortunately, you can’t insure against a key employee quitting, but insurance policies can be used to create a targeted retention incentive – “golden handcuffs,” to put it indelicately.
A key person, strictly by the numbers, is someone whose absence would create a measurable loss to the company and whose contribution would be difficult to replace quickly. They may be the functional majordomo of the business, the leader behind the leader whose deft touch keeps the plates spinning. They may be a rainmaker, driving a significant fraction of revenues. Or they may be someone with rare technical knowledge.
In practice, business owners have many reasons to insure an employee’s life, from the sentimental to the strategic.
Sole proprietors may also consider a key person insurance policy, with the benefit allowing survivors to pay off the business’s liabilities and retain ownership of important assets like intellectual property.
The cost of a policy depends on many factors, including age, lifestyle risks, coverage amounts, additional riders and the structure of the policy.
Certain types of life insurance policies have a cash value, a portion of the premium that can grow from interest or investments, tax-deferred, over time. This cash value can be accessed in a number of ways – through loans, as collateral, or as withdrawals.
This cash value can be used to fund other types of employee benefits, complementing a business’s recruitment and retention strategies.
For example, policies can be structured to end after a set number of years – say when the key person may wish to retire – and the cash value of the policy is then paid as a retirement bonus. At the time of payment, the business can deduct the cash value from earnings while the employee would pay income tax. Timed appropriately, this can be used as a tax-deferment strategy, providing a deduction to a business during a year when tax liabilities are higher or when the employee’s tax liabilities are lower – say in the year after retirement.
These types of strategies are not without risk, as these types of agreements are considered non-qualified, meaning they fall outside the regulatory reach of ERISA, the rules and guarantees that govern 401(k)s and other common employer-sponsored plans.
The customizability of these strategies creates complexity quickly, so a goals-based discussion with a financial advisor or insurance agent is advisable.
These policies have exclusions and/or limitations. The cost and availability of life insurance depend on factors such as age, health and the type and amount of insurance purchased. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition if a policy is surrendered prematurely, there may be surrender charges and income tax implications. Guarantees are based on the claims paying ability of the insurance company. Raymond James does not provide tax advice. Please discuss these matters with your tax professional. Insurance products offered through Raymond James Insurance Group. Raymond James & Associates, Inc. and Raymond James Financial Services, Inc. are affiliated with Raymond James Insurance Group.
