This fact sheet provides additional information to help with understanding the investment, tax and other financial planning concepts that we have discussed with you or included in your Statement of Advice.
Please contact your adviser if there is any aspect on which you need further information or clarification.
What is Key Person Insurance
The most valuable resource of any business is its staff and, in particular, its key people.
A key person is anyone whose absence, or loss, from the business, would have a significant negative impact. A business owner, an employee, or a supplier to the business may be considered key.
Loss of key staff can affect every aspect of your business - revenue, profit, goodwill and ultimately the sale value of your business.
Key person insurance can protect your business if a critical employee (or another key person) can no longer work in the business due to disability, trauma or death. By providing a cash benefit, the insurance can protect against falls in revenue, or be used for a capital purpose such as paying off a loan.
You may have other avenues open to you to address the absence of a key person, such as additional borrowing, capital injections from shareholders or selling assets.
However, you should consider the risk that these solutions will not be available to you when needed and the time it takes to implement them if they are. Key person insurance policies can be effected quickly, meaning your business can continue operating and maintain its value.
Types of insurance
Key person insurance can provide cover in the event of the death, total and permanent disablement (TPD) and trauma of a key person.
As business and personal circumstances vary, you should involve your accountant and financial adviser when thinking about the types of cover that are suitable for your business and how you should structure the insurance.
Ownership
Unlike Buy Sell Insurance, which is owned by the owners or related private structures and protects the owners against an unplanned exit of another owner, Key Person insurance is typically owned by the trading entity itself.
Tax considerations
Your accountant or tax consultant can advise you on the tax implications of key person insurance for your business.
Broadly speaking, where you take out key-person insurance to mitigate risk to taxable income, the premiums may be tax-deductible.
If you take out key-person insurance for a capital purpose, such as to repay debt or compensate for the loss of goodwill, then your insurance premiums will likely not be tax-deductible, with the proceeds of the insurance policy taxable under the capital gains tax (CGT) provision.
You and your professional advisers
Designing an effective key person insurance strategy requires your financial adviser, accountant and solicitor to work together. Each professional brings their own unique skill sets and knowledge of your personal and business situation.
Accountant
Responsible for:
- reviewing and establishing business and personal structures e.g. operating entities, holding companies and trusts
- advising on the tax implications of insurance premiums and benefits
Financial adviser
Responsible for:
- advising on insurance products and features
- managing the underwriting process
- advising on coverage amounts
Solicitor
Responsible for:
- drafting and reviewing transfer agreements
- drafting and reviewing contracts
- reviewing and updating wills and power of attorney
Example
Karen owned a successful interior design firm, and other professionals in her industry held her in high regard. The firm experienced substantial growth, and she was regularly quoted in media articles and industry journals on design matters.
Karen recognised that her value to the business came from her focus on design, so she employed Matthew as a general manager to meet the operational needs of her growing business.
Matthew dealt with the employment arrangements of staff, office renovations, marketing, client billing and other back-office functions. He helped reduce expenses and increase profits. Karen could see that Matthew was now a key person to her business, and if he died or became permanently or temporarily incapacitated, there would be a significant impact. So Karen took out a Life and Trauma insurance policy with Matthew as the insured life.
When Matthew suffered a heart attack a year after joining the business, Karen could claim on the Trauma policy, and the business received the insurance proceeds. This lump sum payment helped Karen's firm maintain its profitability by employing and training a temporary replacement until Matthew could resume work.
Key Person Insurance Checklist
- Identify the key person(s) in your business.
- Estimate how long it would take to replace the key person(s).
- Specify the type and amount of loss to the business if the key person(s) died, suffered total and permanent disablement or a trauma. Your financial adviser and accountant will be able to help you estimate the potential loss.
- With the help of your financial adviser, examine the types of insurance required, e.g. life, TPD, trauma.
- Discuss policy ownership options with your financial adviser and accountant.
- Confirm with your accountant the tax treatment of the insurance premiums and insurance proceeds.
- Speak to your solicitor to determine if legal agreements are required to be drafted, or revised, to ensure efficient transfer of insurance proceeds to the intended parties.
Important Information
Walbrook Wealth Management is a trading name of Barbacane Advisors Pty Ltd (ABN 32 626 694 139; AFSL No. 512465). Barbacane Advisors Pty Ltd is authorised to provide financial services and advice. This post is general information only and is not intended to provide you with financial advice as it does not consider your investment objectives, financial situation or needs, unless expressly indicated otherwise. You should consider whether the information is suitable for your circumstances and where uncertain, seek further professional advice. The author has based this communication on information from sources believed to be reliable at the time of its preparation. Despite our best efforts, no guarantee can be given that all information is accurate, reliable and complete. Any opinions expressed in this email are subject to change without notice, and we are not under any obligation to notify you with changes or updates to these opinions. To the extent permitted by law, we accept no liability for any loss or damage as a result of any reliance on this information.
