Key Person Cover

​What is it?

  • Keyperson cover is insurance purchased by a business on the life of an owner or employee whose services contribute substantially to the success of the business. The company is the owner and pays the premiums and therefore is the beneficiary of the policy.

  • Because complete control of the policy rests with the company, the insurance may be considered a company owned asset.

 

Keyperson Insurance has many uses but there are three main purposes:

  1. The Protection of the Business - The cash received from an Insurance Policy on the death or disability of the key employee will assist the company in the preservation, stability and continuation of the business, protecting other employees from losing their employment and will also assist in recruiting an outsider comparable to the deceased employee.

  2. Finance – A special advantage of Keyperson Insurance is that it constitutes an emergency reserve, apart from all other assets, which is not subject to business fluctuations. It could also be used to stimulate confidence in creditors.

  3. Provision for the Key Employee or his/her dependents – Keyperson Insurance may also be used to provide or supplement a retirement benefit for the key employee or to finance a benefit in whole or in part to the dependents of the key employee on his or her death or disability.

How to effect Key Employee Insurance


The employer takes out a policy on the key employee’s life and/or ability to work and pays the premium. If the Keyperson Insurance is effected by a registered company, the company should pass a resolution to effect the insurance and such a resolution should contain the necessary details regarding the insurance policy and the purpose for which the policy has been taken out.


The Types of cover


Three covers should be considered for Keyperson cover as insurance on the key employee's life is not the only option, nor should it be:

Please click on each of the covers for more information.

Income Tax in relation to Keyperson Insurance

 

  • ​Every Keyperson insurance policy will cover a purpose. It is the purpose that determines the tax implications.

  • In certain circumstances the tax payer can claim a deduction under section 51 (1) of the Income Tax Assessment Act. This section allows a tax payer to deduct from assessable income “losses and outgoings” to the extent that they are incurred in gaining or producing the assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income.

  • It is important for the employer to determine what the purpose of the benefit will be for. Before any determination can be made of the deductibility of the premium or the assessability of the policy proceeds for Keyperson Insurance, it is necessary to determine whether the purpose for which the policy was effected was for a revenue or capital gain purpose.

  • The general ruling is, if the purpose is for revenue i.e. covering loss of profits, cost of replacing the key employee, providing a gratuity to the employee’s dependent premiums are tax deductible and claim proceeds are assessable income

  • From this it necessarily follows that whatever is determined as the amount of insurance required, consideration will have to be made as to the amount of Tax to be paid. e.g. If the policy is for $1,000,000; tax of $300,000 will be paid (Company Rate of Tax 30%).

  • If the policy is put into place for Capital Purposes i.e., capital protection, repayment of a loan, to replace lost goodwill, to offset or stabilise a liquidity problem: premiums are not tax deductible and claim proceeds are not assessable income.

Valuation of Key Employee


The most difficult evaluation of any Keyperson case is just how much the company will lose in the event of the untimely death or disability of that key employee.

In an old established company where earnings usually depend on a large number of key employees one death or disability may not mean a great loss. But in a situation where a new company is breaking new ground, especially in new technology, a key employee’s early demise could affect future earnings by many millions of dollars.

When assessing the value of a key employee it is now becoming more important to establish the reasons for insuring the key employee. The following are some examples of reasons for Keyperson Insurance:

 

  • To offset the loss of a key employee’s services.

  • To offset the loss of any unfinished business incurred by his or her death or disability.

  • To offset the loss of clientele attracted to the firm by his or her personality and ability.

  • To offset the loss of employee unity and working harmony which is held by his or her good management and understanding.​

  • To offset the loss of future expansion of the firm.

  • The loss from other stabilising and profitable efforts on his or her part.

  • The need to cover loss in credit standing of the corporation, for example: to repay corporate loans which have been extended because of the key employee’s abilities.

  • To cover the cost of seeking and training a key employee replacement.

  • To make provision for this key employee and to protect his widow and other dependents.

  • To insure the human life assets of the business, in order that there is continuity and the ability to repay debts in accordance with the law.

 

This is tricky area that requires specialist advice. Please give our office a call on 02 9633 5530 if you are considering the value of Keyperson Insurance for your business
 

Please note that this information is general advice only. Please click here for more information.

​Call us Australia-wide on 02 9633 5530​​

Loufin Pty Ltd (ABN 78 002 811 145) is located at 403/55 Phillip Street, Parramatta NSW 2150. Loufin Pty Ltd is a Corporate Authorised Representative of Aon Hewitt Financial Advice Limited,

ABN 13 091 225 642, AFSL No. 239183, Level 33, 201 Kent Street Sydney NSW 2000.