Key Person Protection

This type of protection helps to reimburse a business for economic loss in the event of a key employee’s death. Generally, a “key” employee is highly paid and has significant input and impact on the management of a business, as well as the financial bottom line. Key employees may or may not be owners, but are integral to the business. Loss of such employees can cause adverse credit ramifications; loss of client relationships; missed sales opportunities; and/or costly replacement expenses.

Key person insurance is purchased by the business with the employee’s consent, is owned by the business and the business is the beneficiary of policy proceeds in the event of the employee’s death. Determining the proper amount of key man coverage is critical, and typically is calculated by a contribution to earnings method or cost to replace experience method. In either scenario, the goal is to protect the business against monetary loss or business interruption.

While premiums are not deductible, death benefits may be exempt from federal taxation if structured properly. However, depending on the structure of the plan and business status of the organization, there may be other tax implications that should be carefully considered.

Nonqualified Deferred Compensation Plans

Deferred compensation plans are arrangements in which employers provide additional retirement income, death and/or disability benefits for select employees. You may also have heard these arrangements referred to as “salary continuation” plans.

As they are “nonqualified,” there are no tax regulations about which employees must be afforded these benefits, thereby allowing the business to be selective as to who will participate. Employees receive an agreed upon sum of money over a fixed period of time, beginning at his or her anticipated retirement date. Should an employee die after such payments have begun, the benefits are paid to the designated beneficiaries.

Buy/Sell Cross -Purchase Strategy

Cross-purchase buy-sell plans utilize life insurance protection to ensure viability of a company in the event of the death of a key employee. These arrangements are most commonly used for closely held businesses, partnerships and LLCs. Pursuant to drafted legal documents, owners purchase and own life insurance policies on all other owners. Premiums may be paid by the policy owners personally or by the business, depending on the tax structure desired. When one of the owners dies, the buy/sell agreement is triggered and the proceeds are typically used to purchase the deceased’s share of the business.

Buy/Sell Redemption Strategy

In this strategy, pursuant to drafted legal documents, the business purchases, owns and is the beneficiary of a life insurance policy on each owner. All of the policy premiums are paid by the business, though they are not tax deductible. Upon the death of an owner, the business receives proceeds (generally tax-free) and uses the proceeds to purchase the deceased’s interest in the business from their estate.

Split-Dollar Arrangements

Pursuant to drafted legal documents, the employer purchases a cash value life insurance policy on the employee and policy premium payments and death benefits are divided in a predetermined manner. In some cases, the employer may pay all premiums (commonly called economic benefit split-dollar).

The purpose of the arrangement is to attract and retain key personnel by offering them greater life insurance protection at typically lower out-of-pocket costs than personal coverage. Businesses make their investment back at the time of the insured’s death through a portion of the tax-free death benefit equal to the greater of a policy’s cash value or the total of premiums paid. The insured’s beneficiaries receive the remainder of the policy’s proceeds, typically income tax-free.

Executive Bonus Plans

This is a very straightforward benefit that can be offered by an employer to attract and retain key people who are interested in, or in need of, additional life insurance coverage. Pursuant to a legal agreement, the employer pays the premium on an individual life insurance policy purchased by the employee. The premiums are tax deductible as compensation for the business and taxable to the employee as a bonus. The employee retains full control over the policy, including naming or replacing beneficiaries, who typically receive the death benefit income tax-free.