About Key Man Insurance for Business and Key Man Life Insurance Tax

You probably have done your research concerning Key Man insurance, but you are still wondering about how the Key Man life insurance tax works or how it would be beneficial for your situation. There are so many insurance providers or companies out there, which can make narrowing down your option confusing. It may be handful too! If you have narrowed down the pick to Key Man, then you have got closer to your main purpose. But you should also know more about the company or the insurance type, including about the Key Man life insurance tax.


What Is Key Man Life Insurance?

Basically, this policy is providing financial protection and security for a business (or a company) if one of the key employees passes away. This kind of insurance coverage would be crucial for businesses because it helps make sure that the business would still continue running and operating even after losing a crucial key employee. Not only we are going to talk about the insurance and how everything works, we would also talk about the benefits, especially for businesses.


Understanding More about Key Man (Life) Insurance

It’s safe to say that Key Man (life) insurance is a form of COLI or Corporate Owned Life Insurance that can be used to protect the employees of a business. Its main purpose is to help a business in the recovery process of losing a key employee that has great contribution to the company or whose role is super important in the company. If this person dies, the company doesn’t have to suffer from losing a key role. The key employees are often covering high level executives, top sales people, and other people in decision marker sections.


The policies from Key Man basically offer 3 primary roles:

  • The owner. This is the entity or person buying the (life insurance) policy. The person is also responsible for paying the premiums. As an owner, he/she has the right to transfer, sell, or change the policy’s terms.
  • The insured. This one is the policy holder, in which the death benefit would be payable. It’s quite common that the premiums would be linked directly to the person’s lifestyle and health.
  • The beneficiary. This is the recipient of the death benefit. The person would get the money in the event the insured passes away during the coverage term.


Here’s the common example: A as the owner of the company “Sea Run Wild” insures B (the executive manager) as the policy holder. The beneficiary is typically the Sea Run Wild, to make sure that the company can stay on the ground after B passes. In the event B passes away, the death benefits can be used to make sure that the business will stay running despite B’s passing. It’s also possible that the death benefit is used to help B’s family, usually given as financial assistance to ease off the burden of the loved ones left behind.

As you can see, the policy from Key Man is quite different from other (life insurance) plans. In most cases, the business would be the owner as well as the beneficiary of the coverage. The employee (or the insured) naturally doesn’t have any saying within the policy. However, before the company buys the policy, they must notify or let their employees know about it. Employees have the right to know the basic intention of buying the insurance. The company must also get the employees’ permission (in writing) because the employees would be the one providing info on the policy. In most cases, the company can use the so-called Employer Owned Life Insurance Acknowledgement and Consent Form. It is able to manage everything. Businesses need to know the details of the Key Man life insurance tax before making the decision to have one.


How Does the Insurance Work

Aside from knowing the Key Man life insurance tax, you should also know how this insurance coverage works. So, when a key employee passes away, the condition can affect the company and its business quite significantly. When a company loses its key employee, it can lead to lost customers, decreased productivity, and even the business going down. That’s why the insurance policy from Key Man is designed to help prevent (or at least reduce) the severe impact through financial protection coverage.

The death benefit (from that key employee) can be useful to assist covering some of the significant losses. The key employee may not be replaced, but expenses (resulting from his/her demise) can be covered and minimized. The policy itself can be beneficial to offer financial stability of the family (of the employee).

Key Man life insurance comes in two major types: the whole life and the term life insurance. Whereas term life policy provides coverage within a certain set of time (around 10 to 40 years), the whole life policy provides the coverage for the policy holder’s entire life. In short, businesses are able to buy the Key Man (life) insurance plan for the sake of their key employees. The death benefits can be handy to help the company cover for the possible loss of cost from losing the employee.


The Life Insurance from Key Man

Aside from the Key Man life insurance tax, you need to know whether to choose the term life insurance of the permanent type. Term life is cheaper because it is only applied within a certain time only (the longest is likely 40 years) while the permanent is applied for a lifelong period. However, you should realize that company’s needs will likely change from time to time. That’s why the term coverage would likely be more suitable for your business’ needs.


Who Needs the Key Man (Life) Insurance

Aside from knowing who needs such an insurance, you should know that SBA (Small Business Administration) and banks tend to require Key Man insurance for investments and loans. It’s due to the fact that small companies may have hard times surviving with one (or two) employee. It also happens to investors. They need a type of assurance that the loss of key people won’t affect the company in such a worse and drastic way – not to the way making it bankrupt.

As you are aware of, companies would purchase the Key Man insurance to protect themselves, especially from significant losses. There are some conditions that make businesses buy this kind of insurance:

·         The business brand is connected to related to a person’s name (the name of that key employee)

·         The company’s overall performance is heavily affected by the employees’ skills and abilities. Projects regularly connected to their abilities

·         If the employee goes away or leaves, it’s possible that the business may suffer from losing customers

·         If the business loses the employee, it would affect their credit. Or the condition will cause the (business) loan to be due

Basically, if someone or several people within the company is extremely crucial to the entire operation and business, it’s advisable to buy the Key Man policy. It’s highly likely that if they die, your business may collapse or not survive. The policy can also be used to pay debts being left behind. It can also be used to return the money to investors.

The key executive insurance can also be handy as incentive, especially for employees to stay with your business. Let’s say that you purchase a permanent life policy, which can be given to these employees when they have retired. Or you can also give the money to them after several years if they have performed well within the job.

The Insurance Tax

So, what should you know about Key Man life insurance tax? First of all, the cost of the insurance premiums isn’t tax deductible. Second, it should be paid with the after-tax dollars. However, the companies can sometimes deduct the overall cost if the taxable income of the employees increases. In most cases, the death benefit from this policy would be paid without the income tax. The only exception applies for C corporations, in which the death benefit is included within AMT calculation.

Another thing about Key Man life insurance tax that you should know is that if you sell the insurance policy of the key employee, it’s possible that you would be charged with taxes. How much money that has been paid (in premiums) would determine the amount of taxes that you need to pay. Every year, the company needs to include the info about the coverage with the corporate tax return. The information usually includes how much coverage they own, how many employees have been insured, and whether these key employees have given their permissions for buying the policy.


Employees Tax Treatment

So, how is Key Man life insurance tax applied or implemented? If the company is the only owner as well as the beneficiary from the key employee policy, the insured employee won’t have any tax implications. However, if there is a transfer ownership (usually from the owner to the key employee), then be ready to pay the tax because it would be considered as a compensation.


The General Cost

There is no such a thing as a uniformed cost when it comes to insurance. There are some contributing factors that would affect your insurance premiums.

  • The purchased policy types. Term (life) insurance is relatively less expensive when compared to the permanent insurance type. It’s because the term life insurance policy are only set within a certain period only and it doesn’t accumulate cash value. The permanent insurance, on the other hand, can offer different benefits and it has various risks and costs.
  • The lifestyle and health condition of the insured employee. Depending on the employees’ hobbies, family history, age, occupation, driving record, age, and general health, it would affect the insurance premiums. In general, if the employee is young and healthy, the premium may be lower because they aren’t considered risky. However, employees whose driving record is poor (often involved in accidents and incidents) and they like doing extreme sports as their hobbies, their risk factors would be high. The premiums will likely be higher.
  • The death benefit. Naturally, if you have more coverage, the premiums would be more expensive.


Be advised that you may have to deal with a pretty expensive Key Man life insurance if you want to insure a less healthy employee or an older employee. It’s even possible that you won’t find the suitable coverage at al. You can find a replacement or utilize a (deferred) annuity within Section 162 Executive Bonus Plan for your backup.


Final Words

It’s advisable that you work with a professional financial expert or skilled insurance agent that can help you manage your insurance needs. A professional would know what your business needs and he/she can adjust or manage your requirements. They can also advise you about Key Man life insurance tax.

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