Untimely Death of a “Star” Employee – Key Employee Life Insurance

Untimely Death of a “Star” Employee – Key Employee Life Insurance

November 09, 2015

Have you ever imagined what would happen if one of your key employees suddenly died?

What would it take in time and money to replace this valuable individual? Could this loss cost the business valuable clients or contacts during the transition time?

Answering these questions and many more can haunt a business owner. That’s why businesses that have key individuals that are vital for the success of the company need to protect their business with Key Employee Insurance.

How it works

The primary function of Key Employee Insurance is to offset the business impact from the loss of a key employee. The policy is purchased by the business so the business pays the life insurance premiums and in the event of the key employee’s death, the business receives the death benefit. The death benefit then could be used to train new individuals to replace the key employee.

Importance of a well designed policy

It is important that the life insurance beneficiary and ownership of the policy must be the business. If the employee’s spouse or family member is the beneficiary named on the policy the IRS could claim that the policy was providing coverage personally hence creating a taxable event. The IRS then could claim the insurance premiums paid for by the business as income creating an additional taxable event in the form of income taxes. Furthermore, in the event of the key employee death while the spouse or family member is listed as the beneficiary and the business as the policy owner, the death benefit would be fully taxable as ordinary income to the beneficiary.

Which is best for your business life insurance:
Term vs. Whole Life

Deciding to purchase Key Employee Insurance is the first step in securing not only your business’s future, but also your family’s financial security. The next step is deciding between Term or Whole Life Insurance. Both types are have certain advantages and disadvantages that must be understood before making a decision.

Term Insurance – The Low Cost Alternative

A term policy is just what it sounds like, a policy with a set duration(term) in which the policy is enforce. Once the duration expires the policy owner must decide to renew (if the policy is renewable) or let the coverage end. Term Insurance is the low cost alternative to whole life insurance, which enables the insured to buy a larger coverage amount for less money. Coverage periods are usually between 5 and 30 years.

Whole Life – The Permanent Solution

Whole Life Insurance is a permanent insurance plan that does not have a duration in which the policy will expire. The policy will stay inforce as long as there is money to pay the policy premiums. Due to the fact the policy won’t expire until the death of the insured, whole life insurance policies cost more for less coverage than term life insurance. The advantages of whole life are: cash value and the policy has an indefinite period of time.

Choosing between term and whole life depends on the individual and/or business. Both have advantages and disadvantages, but in most cases term life insurance has the best rates for coverage levels.

The need to have a Buy-Sell Agreement

Now that we’ve looked at how Key Employee Life Insurance works it’s important for business with one or more owners to protect their family and business interests with a Buy-Sell Agreement.

If you own any part of a business you must set up a Buy-Sell Agreement. It’s a legally binding agreement that requires one party to sell, and another party to buy ownership interest in the business. The Buy-Sell Agreement is designed to protect the business from certain life events referred to as the Five D’s: Since our focus is on Key Employee Life Insurance we will concentrate on the first “D” – Death.

The five D’s are:

  • Death (which will be our focus)
  • Disability
  • Divorce
  • Departure
  • Disqualification

There are many different types of Buy-Sell Agreements and we HIGHLY recommend consulting an attorney before setting up the agreement. Since we are discussing Key Employee Life Insurance, we will focus on how the life insurance policy would act during the life of the owners and the death of a business owner. The two most common types of Buy-Sell Agreements are Cross-Purchase and Entity Buy-Sell.

Two Most Common of Agreements

Cross-Purchase Agreement

The Cross-Purchase Agreement is a legally binding agreement between the business owners where if one owner dies the surviving owners would buy out the business interest of the deceased. By purchasing a life insurance policy where each owner has a policy on the other and is listed as owner and beneficiary on the policy death benefit could be used to buyout the deceased owner’s shares in the business. This type of agreement and life insurance policy is simple when there are two owners, but gets more complex with more owners.

Entity Buy-Sell Agreement

The Entity Buy-Sell Agreements is a legally binding agreement where the business itself owns the policy, pays the policy premiums, and is the beneficiary of the life insurance. If one of the owners dies the agreement would pay the agreed-upon amount to the deceased heirs in order satisfy the agreement.

Advantages of Key Employee Life Insurance

  • Tax-free death benefit as long as the policy is designed and executed correctly
  • Reassurance that the business will continue in the future
  • Increased creditworthiness for commercial loans
  • Retention of key employees
  • Policy cash value may be available depending on the type of policy purchased

Insurance Experts You Can Trust!

Barbee Jackson Insurance offers one-on-one insurance experts that understand your business. No nameless voice on the other end, just a dedicated insurance professional who is ready to surpass your expectations. Call us today at 1-850-389-2001 and let us show you the difference.