Businesses spend a lot of money insuring buildings, equipment, and vehicles but their most valuable asset, people, tends to be overlooked.
What if a key person or business owner either passes away, is accidentally killed, or falls critically ill, how would the business cope? Their death could be catastrophic, threatening the firm’s survival.
A solution is a key person policy.
The policy would be written on the key person’s life but the policy owner would be the company.
Any claim paid would go to the company to provide the business with a sum of money, should such an event occur.
This could be used to protect against a fall in profits, recruiting and training a replacement, and the loss of important business contacts if the key person is not there to maintain relationships possibly creating the danger of clients and suppliers losing confidence in the organization.
A key person is an individual whose skill, knowledge, experience, or leadership contributes to the financial success of a business directly or indirectly such as a chairman, managing director, marketing manager, IT specialist, finance director, or sales manager.
Website, Investing Answers, puts the matter thus:
“Losing key executives, particularly founders, can be very traumatic for companies. Their talent is usually hard to come by, and their roles are often more than just symbolic – in many cases these executives are the ‘face’ of a company.
“When these executives die, often it interrupts production or throws a big wrench into whatever is going on at the time. Key person insurance is intended to help companies overcome those hurdles.”
Cover can provide peace of mind at a relatively small cost.
For example, uklifeinsurance.co.uk cites a 34-year-old non-smoking male, level of life cover £207,231, on a 10-year term at a cost of £8.50 a month.
Key person insurance goes back a long way, and so does the way in which it is viewed by HM Revenue & Customs.
Indeed, it dates from guidance set out by the then-Chancellor of the Exchequer in 1944.
In answer to a Parliamentary Question, Sir John Anderson stated: “The general practice in dealing with insurances on the lives of employees is to treat the premiums as admissible deductions, and any sums received under a policy as trading receipts, if the sole relationship is that of employer and employee; the insurance is intended to meet loss of profit resulting from the loss of services of the employee; and it is an annual or short-term insurance.”
But the Anderson Rules also make clear that the tax treatment depends on the specifics of each case and rests with the assessing authorities and the Commissioners on appeal.
Hence the mantra that if tax relief is given on the way in the proceeds are taxable on the way out, and vice versa, is described by Aegon as a “myth.” HMRC generally takes the view that key person insurance is tax-efficient if it is taken out “solely for the purposes of the business”.
Specifically, where it is to protect the business from any shortfall in profits that have stemmed from the loss of the employee, then the premiums are not taxable.
But if a key employee has a substantial number of shares, then the key person insurance could potentially be seen as being taken out for their own interests, instead of the business.
Especially if critical illness cover is added to the policy.
It’s always best then to check with a financial advisor or the local tax office before making assumptions.
Not bothering with key person insurance only works up to the point when you desperately wished you had taken it out.