Understanding Key Person Insurance

Key person insurance stands as a crucial form of business insurance. Although it lacks a legal definition, we generally understand it as a policy a small or medium-sized business takes out. This insurance safeguards the business against financial losses due to the death or extended incapacity of a specified business member.

Policy Terms and Business Benefits

The policy’s duration aligns with the key person’s period of usefulness to the business. It aims to protect profits and ensure business continuity. Instead of indemnifying actual losses, this insurance provides a fixed monetary sum. This sum is payable upon the insured person’s death or critical illness, as defined in the policy terms and conditions.

Eligibility and Coverage

Any employee, whose knowledge and contribution are vital to the company, may be the subject of a key person insurance policy. An employer might take out this policy to mitigate costs associated with hiring replacements or training successors, and to cover losses from decreased business transactions during the transition.

Identifying a Key Person

The business can consider anyone whose absence would financially strain the company as a key person. This person could be a director, a partner, a leading salesperson, or someone with unique and valuable skills or knowledge.

Taxation Considerations

Taxation of key person insurance hinges on principles established in 1944 by Sir John Anderson, then Chancellor of the Exchequer. The business can deduct premiums as a business expense if:

1. The proposer and the insured have only an employer-employee relationship, except for shareholding directors.
2. The policy covers only loss of profits.
3. The policy’s term aligns with the key person’s period of usefulness.
4. The employee does not hold significant shareholding, often less than 5%.

If the premium is a permitted allowable expense, policy proceeds typically are taxable. However, tax treatment of premiums and benefits varies, and businesses should consult their local Inspector of Taxes for guidance.

Policy proceeds usually avoid taxation, unless they are payable in installments. Again, businesses should seek advice from the local Inspector of Taxes before implementing the policy.

When setting the sum assured on key person cases, it’s crucial to consider the effects of taxation.

Policy Value and Duration

These plans hold no cash value at any time and will cease at the end of the term. If the business fails to maintain premiums, the cover will lapse.

Keep in mind, information regarding taxation levels and reliefs depends on current legislation and individual circumstances. These are not guaranteed and are subject to change.