Successful business owners need ways to protect their companies, compete for top talent, reward employees and plan for a financially secure future. An excellent financial planner understands these needs and know the various roles insurance play in these situations. This is the second one of a 5-part series dedicated to businesses and the role of life insurance in solving some of the concerns of business owners.
If your client is a business owner and the financial plans you have made with them hinges on business income or if a big part of their net worth is in the business. It is critical that you bring this often overlooked problem to your client's attention.
Key Employee Coverage
In my past roles, I was Chief Operating Officer for two very different companies, one was for a national brokerage where I had to work with people working remotely from around the country and another was a boutique insurance firm dedicated to serving the ultra-affluent where all of the operations were in one office. Both roles called for different sets of management styles and talents but the essence of running a firm is the same for both. In the same vein, I was a key employee for both firms. What's also the same is the fact that I always had one or two other employees that I identified as essential to the success of both businesses.
Every employee has a role to play and while every single one of them is important, I found that a key employee may be a partner, top executive or a member of my team with unique talents, experience or skills critical to the prosperity of the firm. They are usually very hard and costly to replace.
Companies often overlook their most valuable asset - key employees. If you ever experience training and investing in someone then see them leave the firm for whatever reason, you know exactly what I mean. If you you ever trained that person's replacement, regardless of how much more experience this new person might have, you could imagine the cost of getting a new employee up to speed. When employees leave a company, there is usually a professional notice given (at least two weeks). But what happens when someone unexpectedly passes away?
How do business owners protect their businesses from the loss of a key employee?
Life insurance on the key person protects businesses from the financial impact of the loss of an essential employee. Basically, the business can purchase a life insurance policy on a key employee after giving them notice and receiving their consent.
What are the advantages of key employee coverage for a business?
- Income tax-free death benefit proceeds are paid to the business if key employee dies while policy is in-force.
- Death benefit proceeds could fund recruitment and training efforts to replace a key employee.
- Capital to replace profits or help settle any loans due or for other expenses during the transition caused by the loss of key employee.
Again, I am not a lawyer or an accountant. I'm simply here to educate you about insurance. That said, you should know that for federal income tax purposes, life insurance death benefits generally pay income tax-free to beneficiaries pursuant to IRC Sec. 101(a)(1).
In certain situations, however, life insurance death benefits may be partially or wholly taxable. Situations include, but are not limited to: the transfer of a life insurance policy for valuable consideration unless the transfer qualifies for an exception under IRC Sec. 101(a)(2) (the transfer-for-value rule), arrangements that lack an insurable interest based on state law, and an employer-owned policy unless the policy qualifies for an exception under IRC Sec. 101(j). It is also worth mentioning that annual increase in policy cash values and death benefit proceeds may have corporate alternative minimum tax implications.
When working with an insurance professional, all these things should be discussed prior to purchasing a life insurance policy on a key employee. Remember, businesses carry insurance coverage to protect them from loss of property and equipment. Next time you are working with a business owner, make sure to bring this matter to their attention. As their financial planner, you never know how much they rely on a key employee to run their very successful businesses. You don't want the "cookie to crumble" due to an unexpected loss of their most valuable asset - a key person.
If you are a fee-only planner, advisor or a client and would like to know more about this topic, please email me at email@example.com or share this with your friends using the social media links below.
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