Key person insurance, also known as key employee insurance, is a life and disability insurance policy taken out by a business on the life of a crucial employee or owner. This policy provides financial protection to the business in the event that the key person passes away or becomes disabled. Here's a closer look at key person insurance:

Identifying the Key Person: The first step in obtaining key person insurance is identifying the individual(s) whose absence would have a significant impact on the business's operations and financial stability. This could be a founder, a key executive, a top salesperson, or any person whose expertise and contributions are irreplaceable.

Policy Ownership: The business purchases and owns the key person insurance policy, pays the premiums, and is the beneficiary in the event of the key person's death or disability.

Financial Protection: In the unfortunate event of the key person's death, the insurance payout can help cover expenses such as hiring and training a replacement, settling outstanding debts, and ensuring the business continues to operate smoothly during the transition.

Maintaining Creditworthiness: Key person insurance can provide reassurance to lenders and creditors, enhancing the business's ability to secure loans and maintain its financial stability.

Retaining Employees: Knowing that the business is financially secure in the event of a key person's absence can help retain valuable employees who might otherwise be concerned about the company's future.

Buy sell agreements, also known as business continuation agreements, are legally binding contracts that dictate what happens to a business when a specific triggering event occurs. These events typically include the death, disability, retirement, or voluntary departure of an owner or key person. Insurance plays a crucial role in the funding of buy-sell agreements:

Funding Mechanism: Buy-sell agreements can be funded in various ways, with insurance being one of the most common methods. In this context, life and disability insurance policies are used to provide the necessary funds to execute the terms of the agreement.

Ensuring a Smooth Transition: When a triggering event occurs, the buy-sell agreement outlines how the departing owner's share of the business will be sold or transferred. The insurance payout provides the capital needed to facilitate the buyout, ensuring a seamless transition of ownership.

Fair Valuation: The agreement also specifies how the business's value will be determined when a triggering event occurs. The insurance proceeds help fund the purchase of the departing owner's share at a fair market value.

Financial Protection: Buy-sell agreements with insurance funding protect the interests of all parties involved, including the departing owner or their beneficiaries, the remaining owners, and the business itself.

A Split dollar plan offers a creative solution to helping your key employee obtain needed life insurance. Split dollar is a term that covers two different executive benefit arrangements.

The Split Dollar Economic Benefit arrangement provides an income tax-free death benefit to the key employee while providing the business with key person protection.

The Split Dollar Loan arrangement provides the key employee with the ownership of a permanent life insurance policy, the business with cost recovery all at a cost to the employee of the interest on the premium paid by the business.

Allows your business to provide select key employees and offer them executive bonus plans.

Key employee receives valuable life insurance protection and potentially the benefits of owning a permanent life insurance policy.

Business will either be the owner of the policy (the economic benefit arrangement) or will recover the costs of the arrangement (the loan arrangement).

Non qualified plans are plans that you can use to provide additional benefits to yourself and your key employees and executives. A non qualified plan is often used along with a qualified plan as an additional retirement benefit plan to attract and retain key employees. They also offer greater flexibility in who can be covered under the program and are generally easy to establish and administer. Weather you like college football or not, institutions use non qualified plans for their high paid employees.

Jim Harbaugh: The University of Michigan football coach, Jim Harbaugh, utilized a loan arrangement against his life insurance policy as part of his compensation package. This creative use of life insurance provided financial flexibility and additional benefits.

An executive bonus plans, also referred to as a Section 162 plan, allows a business to provide personally owned life insurance as a tax-deductible fringe benefit to select key employees.

If the benefit is for a non-owner employee, an executive bonus plan is appropriate for all business forms, including professional corporations, partnerships and LLC’s. However, this type of plan does not offer any tax benefit for business owners if the business is an S-Corp, partnership or LLC taxed as a partnership. Here are some additional benefits of an executive bonus plans. 

Employer decides who participates and how much of a bonus each employee will receive.

Bonus dollars are tax-deductible to the company as compensation to the key employee.

Simple to adopt with No IRS approval required.

Premiums are reported as “other compensation” on W-2 and are subject to FICA and FUTA taxes.

The key employee will own and control the policy and will have access to the riders, potential cash value growth and death benefit that make up the permanent life insurance policy.

The employee’s out-of-pocket cost is the tax due on the premiums paid by the employer that have been treated as compensation. You may choose to add a cash bonus to the arrangement (a double bonus) to offset the tax amount due.

Policy cash value grows tax-deferred and may be accessed through withdrawals or policy loans*.

Death benefit is paid to the insured’s beneficiaries income tax-free.

Your business may enter into an arrangement with your highly compensated or select group of management and provide them with a supplemental retirement benefit plan that is tailored to both the business and executive’s needs. 

This arrangement is appropriate where the business entity will continue to operate for a long period, at least long enough to pay the benefits promised under the arrangement. Essentially, the business promises to pay a benefit to the executive at some time in the future (often at retirement age).

The executive will only pay tax on the benefit when received, allowing the executive to benefit from tax deferred growth.

The business may informally fund the arrangement with permanent life insurance, providing a source of the funds from both the potential cash value build up and the income tax free death benefit.

The business will receive a tax deduction on the benefit amounts when they are paid to the executive.

The business may be highly selective as to who will receive the benefits and how the benefit amounts are defined.