Estate Planning for Entrepreneurs – Part 1: Key Man Insurance
Key man insurance, as the name suggests is an insurance policy purchased by the business on the lives or life of a few or one key employee.
Having this policy in place is a recognition that, especially in small closely held companies, the loss of one employee can have catastrophic effect on the viability of the company going forward. Think about many of the small or medium sized businesses that are driven largely by an iconic owner or CEO. That person may be the source and repository of the organization’s marketing and sales strategies, and also may be the organization’s go-to person for internal management and still the public face or name associated with the company.
Many of the entrepreneurs who read this will undoubtedly experience butterflies, because this centralization of knowledge and resources happens to be the reality for many of us in business.
A key man policy is part of your organization’s risk management plan, but it should really be secondary to a carefully considered succession plan. The elements of a good succession plan are addressed in another article on this blog.
The business pays the monthly premium for key man life insurance policy and the proceeds of the policy are paid to the business at the death of the key person.
The premium payments are not deductible for Federal income tax purposes, and the payout to the company is also not taxed as taxable income.
It is important that the formalities are observed and respected though. If the employee is a controlling stockholder (50% or more ownership) and the proceeds of the policy are paid to someone other than the company then the proceeds may be included the the key employee’s taxable estate for estate tax purposes.
