We’ve all heard of the most common type of life insurance for business – key person.
But what if told you there were other creative uses for life insurance in your business?
… And since we work with so many businesses, we’ve put together this quick guide for how you can not only protect your business with life insurance, but also attract, retain, and incentivize, key executives and employees in your organization with life insurance.
Quick Article Guide:
- Key Person or Key Man Coverage
- Life Insurance as an Employee Retention Tool
- Buy-Sell Agreements
- Stock Redemption Plans
- Group Life Insurance Plans
- We Can Help!
Key man insurance is insurance on any employee who is an integral asset to the company’s survival. Without this person, or persons, the company could fail or at the very least suffer financial hardship.
The way key man insurance works is through the owner, payer, and beneficiary of the life insurance is the company. If the key person died unexpectedly, the company would have money to continue business until a suitable replacement could be found. Worst case scenario, the money would be used to pay debts to creditors, investors and severance pay to employees if the company could not survive without the key employee. This insurance helps the company avoid bankruptcy in the short-term.
For a small company, or proprietorship, the key person is likely the owner of the company. Without the owner and their expertise, the company would cease to exist. A mid-to-large sized company may have several key employee’s they want to insurance. These employees, their skills and business contacts are essential the company’s existence. It’s important to identify who these key employees are and insure them to protect the company from an unexpected drop in revenue. Without key man insurance on these individuals, the loss to the business could be crippling and takes years to recover. The true cost would depend if a qualified person could be easily found or if an inexperienced, or unproven employee had to be trained.
How much life insurance is needed on a key employee?
This is a difficult question and budget will, no doubt, be a factor. Most life insurance companies will approve up to 5-10 times the key employees’ annual salary including bonuses. Age will be factored in as well on the multiple of income allowed.
The insurance carrier will want to know the nature of the business, when the company was started, net worth of the company, if the key person is an owner of the business, and if all key people will be insured. Insurance carriers will want to see that all key people, or owners of the company will be insured. It’s a red flag to them if any key persons or owners aren’t being insured, unless they are uninsurable.
Want more info? Give us a call and we will explain your options and how much coverage your key employee(s) can qualify for.
Life Insurance as an Employee Retention Tool: Cash Value Life Insurance & Deferred Compensation Plans
Group cash value life insurance plans, including universal life policies with vesting, are a great way to incentivize your best employees to remain loyal to the company. The appeal to these policies is the cash grows tax deferred and are accessible through loans and withdrawals. Employees control the frequency and amount they wish to contribute as well as the death benefit that best meets their needs, assuming the amount is qualified. The employee is the owner of the policy, which means they maintain all rights with regard to naming beneficiaries and electing investments options is it’s a variable life plan. These policies are often used to entice potential employees as part of an executive benefit package, or to fund retirement, but the main purpose of the policy is the death benefit.
Non-qualified deferred compensation plans are another great employee attraction and/or retention mechanism. With this plan, the employee can defer a portion of their salary including bonus pre-tax. The draw to these plans is the employees have the freedom to choose their own investments ranging from conservative to aggressive and similar to cash value policies the cash grows tax deferred until they begin receiving the money. The employee is instantly 100% vested and employer can opt to match contributions as an additional perk.
To fund this plan, the employer buys a life insurance policy on the employee, or group of employees to informally fund the deferred compensation plan. The company is the owner, payer, and beneficiary of the life insurance policy. The deferred compensation is used partially used to pay premiums on the life insurance policy while the employee is alive and employed. For more information about non-qualified deferred compensation plans, please visit here.
A cross-purchase buy-sell agreement’s primary function is to protect the business, the owners, and their heirs should one of the business owners die prematurely. This agreement is funded through individual life insurance policies on each of the business owners.
With a cross-purchase agreement, each owner would buy a policy on each of their partners. The amount of life insurance is equal to their respective share of the net worth of the business. This can get tricky when there are more than a few partners as there will be many life insurance policies to buy. If a company had six owners, the company would need a total of 30 policies. The life insurance is used to maintain the continuity of the business should one of the owners die unexpectedly.
This agreement also obligates the owner’s heirs to sell their interest in the business to the remaining owners. The death proceeds are used to pay the insured’s heirs as a way to buy their share of the business from them. This allows the company to continue current operations without the deceased owner’s family becoming owners and altering the dynamics of the business.
Either the business, or the individual owners can pay premiums on these life insurance policies. It’s important to note that if the business pays the premiums, the death proceeds will most likely be subject to taxes. This is why most companies have each owner pay the premiums to avoid taxation.
This is an ideal agreement for a closely held corporation with more than a few shareholders. In this agreement, the shareholders of the corporation enforce limitations on the transferability of stock held by each party of the agreement. The business then purchases individual life insurance on each of the owners. With a stock redemption plan, the business pays the premiums for each policy and is listed as the owner and beneficiary of the policies. If the shareholder dies prematurely, the corporation buys the deceased shareholder’s interest in the company with the death proceeds.
Two of the main advantages of a stock redemption plan over a cross-purchase is a stock redemption plan is easier to manage when there are multiple shareholders. Also, the corporation will bear the disparity of costs between older/younger and healthy/unhealthy shareholders’ premiums. The disadvantage is the shareholders do not benefit from an increase in basis when the corporation purchases the departed shareholder’s interest.
Whether it is best for your business to get a cross-purchase plan, or stock redemption plan is going to depend heavily on the number of business owners in the company and tax implications of the death proceeds. As mentioned earlier, with a cross-purchase agreement, each owner would need to buy a policy on each of the partners. This could result in the purchase of numerous policies that will need to be applied for and maintained.
With a stock redemption plan, only one policy per shareholder is purchased. Stock redemption plans can be more at risk to estate taxes due to IRS questioning the value of the stock owned by a closely-owned corporation being undervalued by the company. While there are pros and cons to both, it’s important to have something in place to protect the business entity and its surviving owners.
To further review whether a stock redemption plan might be right for your corporation feel free to contact us, or read this article.
Many companies offer some type of group life insurance as part of their basic benefits package to attract qualified employees. These can be term, universal life, variable life or whole life policies. However, in most cases the policies are five year renewable term policies. This means that the premiums, or cost of the policy, is fixed for five year increments. Group term life insurance is one of the least expensive life insurance options a company can provide its employees.
Group life insurance is very attractive to many potential employees who may be in poor health now, or have an unfavorable health history that prevents them from qualifying for affordable life insurance, or any life insurance at all. For employees who fit this profile, they are guaranteed to be accepted for life insurance. This is a sought-after benefit for someone who has the need for life insurance, but is unable to qualify for outside insurance on their own. An uninsurable applicant will want to work for a company that offers group whole life, universal, or variable life insurance as part of their benefits package.
In most cases, the death benefit is limited to one year of the employee’s average salary. There is also usually an option for the employee to purchase additional life insurance as part of a supplemental plan that may go up to 3-5 times their annual earnings. Premiums for the supplemental plans are typically deducted through payroll and paid by the employee.
Portability is an important feature many employees will look. Portability refers to whether or not you have the option for the life insurance to continue if you are terminated, resign, or retire. With group life insurance you may also be able to purchase dependent riders to cover your spouse and children.
At JRC Insurance Group, we shop the top 40 highly-rated life insurance companies to be sure we have the best rates. Our extensive knowledge in setting up a variety of business life insurance policies can help your company attract and retain key employees. Call us today to see how we can save you money with your business life insurance needs. Toll free (855) 247-9555 or get a free instant quote online.