Key man life insurance is insurance that is purchased by a company to help it reduce the risk that may arise from business disruption if a key employee left or passed on. This type of insurance differs from other life insurance policies because in this case, the business is both the beneficiary and owner of the policy. The insured employee does not have active participation or any rights to the policy. However, the company is required to notify the employee of its intention to buy coverage for them.
Cost of Key Man Life Insurance
The amount of coverage to place on an employee depends on the business as well as the employee you are insuring. In principle, you should aim at purchasing enough key man insurance such that the impact that comes with the loss of the insured employee is almost zero. To achieve this, account for the profit and revenue attributable to the person, the cost of replacing the employee, the cost structure of the company and any other value that the employee brings to the company. However, you have to be aware that the cost of the coverage will differ significantly depending on the person you’re covering. For instance, it might not be hard to calculate the revenue of a top salesperson. On the other hand, the value might be less tangible for a successful CEO who brought in many employees into the company.
Tax Treatment of Key Man Life Insurance
The cost of this insurance is not tax deductible. This means that the premiums are paid using after-tax dollars. Also, the company is entitled to deducting the insurance premiums if they are thought to be part of the taxable income of the employee. In this case, the employee is the beneficiary.
During the passing away of the insured employee, the death benefit of the key man policy is paid out to the company free of income tax. C corporations are the only exemptions because the death benefit is included in the calculation of the alternative minimum tax (AMT).
If the company sells the key man insurance policy, it will have to pay taxes, which will depend on the policy’s cash value, the size of the settlement and the amount of money that’s already been paid in premiums.
Additionally, your company will be required to include the coverage details in the corporate tax return.
Before purchasing a key man life insurance, ensure that you seek the services of a tax-professional so that the company can be fully compliant with the requirements.