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Is key person insurance key?

I have a successful plumbing business but I realise my health is critical to us meeting all of our loans and bills. Should I look at key man insurance? And is it tax deductible?

This is an insurance option that many small business owners have taken on over the years.

According to Zurich Insurance less than half of business owners (43 per cent) will have ever even heard of the cover and only seven per cent have taken out life insurance for this purpose.

The purpose of key person cover is to protect the business itself by addressing the potential loss of expertise and the associated costs when a key person is taken out of the play. The sudden loss of a key person from death or disability has a negative financial impact on sales/profits as well as the business’s capital value, goodwill and credit rating. So key person insurance can be used for the purpose of recovering revenue or capital, which includes lost goodwill!

Key person insurance is designed to protect the business should it lose someone who makes such a significant contribution towards the company’s profitability, stability and growth potential.

By the way, the key person doesn’t have to be the owner — it could be a key employee, such as a foreman, a manager, a PA or a key tradesperson.

Just like sporting clubs who insure against the loss of a star player, a smart business should do the risk management and work out what happens to the business if the key man or woman can’t turn up.

The tax treatment of key man insurance is worth noting.

Broadly speaking, key person insurance either needs to be attributed to a revenue purpose (for example, replacing lost income, compensating for loss of profits etc.) or a capital purpose (for example, repaying debts, discharging security over a guarantor’s property, compensating for loss of goodwill etc.).

Zurich says if your business is audited following a claim, the Australian Tax Office (ATO) will not only look at the stated purpose for the insurance in your company records but also the actual use to which the proceeds are put.

If the main purpose for the key person insurance is revenue if something goes wrong, the premium is tax-deductible and the proceeds are assessable for Term, TPD and Trauma benefits, whereas if the company takes out insurance for capital purposes, say to back a loan, the premium is not tax-deductible.

While Term insurance benefits are not assessable, capital gains tax (CGT) will apply to Trauma and Total and Permanent Disability benefits paid directly to the company (as these proceeds do not receive the CGT concession afforded to life insurance proceeds when received by other than the insured or a defined relative).

As you can see, it would be wise to talk to a trustworthy adviser on such an important matter because there are important tax matters to consider, despite the fact that the insurance makes general sense from a risk management point of view.

Make sure you understand what this insurance covers and what you would get and for how long.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

 

 

Published on: Wednesday, May 26, 2010

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