Looking after your employees is important to any business, but what if a key member of staff or director died, could your business still survive? In this article, I’ll explain how Key Man, Key Person or Business Protection Insurance works, the tax benefits and also where to find the best deal.
What is Key Man Insurance?
Key Man Insurance, also sometimes called Key Person Insurance or Business Protection Insurance is a type of Term Life Insurance used to protect key people within a business. Key Man Insurance works in the same way as Life Insurance, if the insured person dies, it pays out a lump sum of cash to the beneficiary.
In this case, the beneficiary would be the business and the money is used to help to replace the key person that died, cover any lost profits and repay any loans or other debts.
Key Man Insurance can be used in any business structure, but the way it’s setup can vary. As it’s for the business, tax can often be reclaimed and the monthly / annual payment can be classed as a business expense.
What does Key Man Insurance Cover?
Key Man Insurance is a very simple product and is exactly the same as Term Life Insurance apart from the beneficiary can be a business as well as an individual.
Key Man Insurance will pay out if the policy holder dies or is told they are terminally ill. Let’s look at the death part first of all.
If the policy holder dies, the policy will pay out the cover amount as a lump sum of cash to the beneficiaries. There are some exclusions, but they are straight forward and easy to adhere to. You will need to check the documents on the cover you get, but here’s a few general ones.
Most insurers will cover suicide, but not in the first 12 months. This of course prevents people from buying a policy and killing themselves just to get a Life Insurance payout, but it does cover people that do later in the policy. This is of course providing that there were no psychological issues known at the time of the policy.
You must tell them everything in the application. When you buy Key Man Insurance or Life Insurance, you will be asked the insurance companies health and lifestyle questions. These are set of questions that help the provider to calculate the risk of insuring you, in a similar way to car insurance where they look at the type of car, it’s value, how many accidents are caused by people driving this car, in this case they will look at your age, your lifestyle, your health, how much cover and how long.
The questions are designed to get as much information out of you as possible, but think about your medical history and be honest, you might have to pay a bit more per month, but it’s not worth lying as it could leave your business or family without money they need. The good news is, around 98% of protection claims are paid out in the UK, the small amount that aren’t are mainly for people not disclosing medical conditions.
Terminal Illness is covered but must be less than 12 months to live. This varies by insurance company, but your doctor must have told you that you have a certain amount of time left to live, if they don’t, you can’t claim. Normally it’s 6, 12 or 18 months. If you are given 12 months or less to live and this meets your policy conditions, the insurance company will pay out the cash early. This gives people the chance to settle their affairs before they die which is a welcome relief for a lot of people. Especially with a business, debts can be settled, and everything tied up rather than leaving a business partner or spouse to sort everything.
Every insurance company has its own set of exclusions, so it’s important to read the terms and conditions or documentation before buying.
There are different business structures in the UK, which have different rules and can affect the amount of tax you pay, who gets the profits and who pays the debts. With Key Man Insurance it could be set up differently for each business structure. The three main business structures are:
Sole Trader – an individual who owns and runs their business, they are often called self employed. They are personally liable for the business’s debts and if they can’t pay, their home or other assets could be taken to be used as payment. Skilled work or tradesman such as electricians, gardeners, plumbers, decorators and plasterers will often be sole traders as it’s easier for them to operate.
Find out more about Key Man Insurance for Sole Traders >> Find out more about other Insurance for Sole Traders >> Find out more about more about Sole Traders >>
Partnerships – a business setup between two or more individuals, the management and profits are shared and all partners hold responsibility for debts. Two heads are better than one so everything can be split and there’s potential for being able to borrow double the money if you need to.
Find out more about Key Man Insurance for Partnerships >> Find out more about other Insurance for Partnerships >> Find out more about more about Partnerships >>
Limited Companies – a business with its own, separate legal entity. The company is setup and registered at companies house and will have one or more directors who are given shares.
Find out more about Key Man Insurance for Limited Companies >> Find out more about other Insurance for Limited Companies >> Find out more about more about Limited Companies >>
Why should I buy Key Man Insurance?
Key Man Insurance is vital for a business that relies on “Key People” for the business to run, but it will vary from business to business. The question to ask yourself is “Can my business carry on trading without that person?” If the answer is no, then it might be worth considering Key Man Insurance.
Let’s look at some examples:
Sandra’s Bakery – Limited Company
Sandra owns a bakery with her friend Julie who runs the marketing and accounting side of the business, they are both Directors, but Sandra bakes all the bread and has been a baker her whole life. If either one of them dies, they both want to carry on running the business, but will need to replace the other for the business to carry on.
Sandra and Julie have setup a Key Man Insurance policy that pays out a lump sum of cash if either one of them die. This will allow them to pay any outstanding debts, hire temporary staff and pay for recruitment bills to replace each other.
As they are both vital parts of the business, the Key Man Insurance policy could be claimed as a business expense and they wouldn’t need to pay corporation tax on the monthly premium. In the event of a claim, the money from the policy would be taxed. To combat this, often businesses will take out more cover for the tax payment.
Without Key Man Insurance, they would need to find a way to continue running the business without the other person.
Matt’s IT Company – Limited Company
Matt runs an IT consultancy, he is the only Director of the company but has employees. James his Web Developer looks after all of the IT infrastructure and maintains the websites for his business and the companies that Matt works with. Without James, Matt would not have anyone else to do this job currently in the business so would have to hire someone new or outsource the work to a separate company.
Matt has taken a Key Man Insurance policy on James as a key person within the business, the policy is owned by the company and is therefore a business expense.
John the electrician – Sole Trader
John is an electrician; he is setup as a sole trader and is the only employee. Without John, the business wouldn’t survive. John also has a wife and 2 children.
If John dies, his business will immediately stop trading and as the only employee, the responsibility will fall to his wife as his next of kin to sort his affairs. The family would be entitled to any business profits after tax but would also need to make sure that the business pays any debts before taking any profits.
He could take out a personal Life Insurance policy, the premiums would be paid out of his salary after tax and not as a business expense. The money would be tax free and go directly to his family, it could be used to close down the company and give them some money to live.
If you can prove that your Key Man Insurance policy is solely for the benefits of the business then you may be able to claim tax relief, however, as a sole trader, the difference between the individual and the business are not defined like a limited company. Whilst you might not be able to claim the premiums as a business expense, the payouts are not taxed if the policy is written into Trust.
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