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Keyman insurance (or key person insurance) is an insurance policy taken out by businesses to protect against the financial loss that may arise in the event a key person dies or becomes critically ill.
The business purchases the policy on the life of the key person, pays the premiums and is the named beneficiary. If the key person dies or becomes critically ill, the business will receive a lump sum which can be used to recruit and train a replacement, offset a loss in profit, manage any detriment in supplier credit terms and/or repay any liabilities to the bank.
The business decides who is a key person. There are no rules on this other than being able to justify the amount of insurance cover. If the business deems that the death of an employee would result in a financial loss sufficient to warrant insurance, then that employee is a key person. Typically the list of potential key people includes: the business owner, directors, employees with specialist skills or knowledge, high performing sales people, operations executives or simply someone who plays a fundamental role in the success of the business.
This aspect is relatively complex and we know from experience that it is not widely understood. The HMRC guidance regarding key person policies states:
And
Then, as a general rule, the premiums will be tax deductible. And if the premiums are tax deductible then the proceeds will be taxed as income to the business.
Conversely, if the policy does not meet these tests, the premiums will not be tax deductible and the proceeds may be tax free. However, HMRC cannot give future assurances that the proceeds will be tax free just because the premium is not allowable against tax.
It is therefore very important to take advice in this area, and to review any existing cover, as many businesses will prefer a structure that has the potential to provide tax free proceeds.
The amount of cover required will depend on an assessment of the financial loss that the business would suffer in the event of the death of the key person. This may be determined, for example, by considering how much profit the key employee creates and the costs of recruiting a suitable replacement. The experts in our Financial Planning team can advise on the level of cover that is right for your business.
In summary, if the profitability and ongoing success of your business is dependent, in part, on one or more key employees, then it’s important to consider key person insurance. It can make the difference between a business surviving or not.
Please take professional advice, as it’s common for key person policies to be structured incorrectly. We’re happy to discuss your requirements and explain how we can support you. Please add your details to the form below and we’ll be in touch.
