Key Person Insurance vs. Life Insurance: Which is Right for Your Business?
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Choosing the right insurance coverage is crucial for financial stability and risk management for business owners and self-employed individuals.
While life insurance is a familiar concept to many, key person insurance might not be as well understood despite its significant benefits for businesses.
By comparing these two types of insurance, their purposes, and benefits, you will gain a clearer understanding of each and can better determine which one is more suitable for your business and personal needs.
What is life insurance?
Life insurance is a policy that provides financial protection to your family or dependents in the event of your untimely death.
The primary purpose is to offer peace of mind and ensure that loved ones have financial support during difficult times.
Types of Life Insurance
Term Life Insurance
Term life insurance offers a lump sum payment to your beneficiaries in the event of your death. This type of policy is active for a predetermined period, known as the term.
If the term expires and no claim has been made, the policy will end. This makes term life insurance a straightforward and often cost-effective option for temporary coverage needs.
Whole of Life Insurance
Whole of life insurance provides coverage for the duration of your life, guaranteeing a payout upon your death.
Due to the certainty of a payout, this type of life insurance typically carries a higher premium compared to other policies. This permanent coverage ensures that your beneficiaries are financially supported whenever the policy is claimed.
Convertible Life Insurance
While similar to term life insurance, it offers a unique advantage: the policyholder can convert the term coverage into a permanent policy at a later date without undergoing a medical exam or proving good health at the time of conversion.
Learn more by exploring Convertible Life Insurance.
Additionally, this type of policy can be converted to a “whole-of-life” policy, providing guaranteed life insurance coverage for the entirety of the policyholder’s life.
Mortgage Protection
Mortgage protection insurance ensures that if you pass away before your mortgage is fully paid off, the remaining balance will be covered.
The coverage amount decreases monthly, aligning with your decreasing mortgage balance. Should the insured pass away, the policy ensures that the outstanding mortgage is paid off in full.
Life Insurance – Coverage Options
Single:
Obtain a quote individually and secure a single policy solely for yourself.
Joint:
This policy covers you and your partner, paying out once. The policy can be set up to pay out on either the first life assured’s death or the second life assured’s death. After the payout, the policy ceases.
Dual:
Dual coverage provides a payout after the death of the first life assured and continues to offer a second payout after the death of the remaining life assured.
This ensures financial support for the beneficiaries of both lives assured. We recommend considering dual coverage, as it typically offers these extended benefits without additional cost in comparison to joint life cover.
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Why Should You Consider Life Insurance?
Life insurance is an essential component of financial planning for several compelling reasons:
Financial Security for Loved Ones: It provides your family with financial stability in your absence, helping to cover living expenses and maintain their standard of living.
Debt Coverage: It ensures that any outstanding debts, such as mortgages, car loans, or credit cards, are not passed on to your family, relieving them of potential financial burdens.
Educational Funding: It can secure funds for your children’s or grandchildren’s education, safeguarding their future opportunities.
Estate Planning: Life insurance can be a strategic tool for estate planning, helping to cover capital acquisitions tax (CAT) and facilitating the smooth transfer of assets to your estate.
Funeral Expenses: This can add a significant financial burden during an already difficult time. To alleviate this, some policies offer a funeral expenses benefit. This benefit provides an advance payment of the cover in place, up to the value of €10,000, to cover funeral expenses.
Income Replacement: In the event of your untimely death, it replaces your income, which is especially crucial if you are the primary breadwinner in your family.
Peace of Mind: Above all, having life insurance means peace of mind, knowing that your loved ones will be financially protected when you are no longer there to provide for them.
Overall, life insurance is not just about covering the financial aspects; it’s also about caring for the well-being of your loved ones after you’re gone.
What is Key Person Insurance?
Key Person Insurance, also known as Keyman Insurance, is a policy taken out by a business to compensate for financial losses that would arise from the death or extended incapacity of an important member of the business.
Why Should You Consider Key Person Insurance?
Key person insurance is an essential safeguard for any business that relies heavily on one or a few individuals whose skills, knowledge, or leadership are crucial to the company’s operation and success.
Here are several compelling reasons to consider Key Person Insurance:
Risk Mitigation: It protects your business from the financial impact of losing a key employee due to an unexpected death or incapacitation. The loss of a key person can lead to significant operational disruptions and financial losses.
Financial Stability: The payout from a key person insurance policy can provide the necessary funds to keep the business stable during the transition period. This can cover recruitment costs, temporary replacements, or even lost revenue during the adjustment phase.
Business Continuity: It ensures that your business can continue operations without major hitches by providing financial support to cover any gaps left by the loss of a key individual.
Pay Off Outstanding Bank Loans: The insurance can be used to settle any outstanding bank loans that may otherwise destabilise the business financially upon the loss of a key person.
Recruit a Suitable Successor: The funds from a key person insurance policy can also support the recruitment and training of a suitable successor, ensuring a smoother transition and continuity in leadership.
Talent Attraction and Retention: Offering key person insurance can be an attractive benefit for top talent, showing that the company values its key employees and is willing to invest in their well-being.
Investment in Business: The payout provides an opportunity to invest further in the business, whether for expansion, innovation, or improving existing processes, thereby strengthening the business’s position in the market.
Key Person Insurance is not just an insurance product but a strategic business tool that helps manage risks and ensure the longevity and success of your enterprise.
Whether you’re running a small startup or a large corporation, this insurance can be pivotal in safeguarding your business’s future.
Explore the impacts of losing a key person on a business by reading this article: Can Your Business Afford to Lose a Key Person?
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Key Person Insurance – Policy Examples
There are different types of policies that can be put in place for Key Person Insurance, for example:
Reducing Term – Business Loan Key Person Insurance
This policy features a standard reducing cover term life insurance, ideal for protecting a business loan. It is more cost-effective than traditional term life insurance because the premium is fixed and lowers as the loan balance decreases over time.
Level Term Life – Business Profits Key Person Insurance
A level term Key Person Insurance policy offers life insurance for a fixed period at a predetermined rate. Optional inflation protection can be added by indexing both premiums and benefits to adjust for inflation.
Convertible Term – Business Profits Key Person Insurance
Convertible term policies operate like level term policies but include an option to extend coverage beyond the initial term without requiring new medical evidence. This feature provides flexibility to adapt the policy as business needs change.
Tax Deductions for Life Insurance and Key Person Insurance in Ireland
Knowing the tax implications of life insurance and key person insurance is crucial for effective financial planning both for individuals and businesses.
Being well-informed helps ensure that you are fully prepared for future financial obligations and can make the most of potential tax benefits.
Life Insurance Tax Deductions
Personal life insurance premiums are generally not tax-deductible. However, there are exceptions, such as policies designed specifically for pension purposes, like pension term assurance, which may offer tax relief on premiums paid.
Pension Term Assurance: Premiums for this type of life insurance, which is integrated with a pension plan, can be tax-deductible. The relief is at the individual’s marginal tax rate, meaning that it can significantly reduce the net cost of premiums.
Pension Term Assurance provides essential financial security for self-employed individuals, those without employer pensions, and those in non-pensionable jobs.
Key Person Insurance Tax Deductions
Key person insurance has different tax implications:
Key Person Insurance Premiums
Generally, key person insurance premiums are not deductible for Corporation Tax purposes. However, the Revenue Commissioners specify certain conditions under which these premiums may be considered deductible:
- The insured individual must solely be in an employer-employee relationship with the business. AND
- The employee should not hold a significant ownership stake in the business. AND
- The insurance must be aimed at compensating for profit loss due to the employee’s absence rather than repaying loans. AND
- The policy should be short-term, covering only payments in the event of death or specified illnesses.
When all the specified conditions are met, the premiums for key person insurance are deductible for Corporation Tax purposes.
If any of these conditions are not met, the premiums cannot be deducted for Corporation Tax.
For example, premiums for a key person insurance policy taken out solely to repay loans upon the death or diagnosis of a specified illness of the individual are not deductible for Corporation Tax purposes.
Key Person Insurance Payout
The tax treatment of the payout from a key person insurance policy can vary. If the policy was taken out to cover a revenue loss, the payout might be considered trading income and thus taxable. Conversely, if it is for a capital loss, the payout may not be subject to tax.
Note:
- You cannot simultaneously claim premium tax relief and receive tax-free benefits.
- If the coverage is intended to protect loans, then the benefits can be tax-free, but premium tax relief does not apply.
- If the coverage is to safeguard against loss of profits, premium tax relief may be available, but the benefits are not tax-free.
- It is advisable to maintain two separate policies if you need to address both profit loss and loan protection.
It’s important for businesses and individuals in Ireland to consult with one of our financial advisors at True Wealth to understand the specific tax treatments applicable to their policies.
This ensures compliance with Irish tax laws and optimises financial planning regarding life and key person insurance policies.
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Which One is Best for a Business Owner?
The choice between life insurance and key person insurance should be based on your individual and business circumstances.
Consider the following:
Personal Financial Responsibilities: If you have dependents or significant personal debts, life insurance is essential to ensure they are taken care of after your passing.
Role in the Business: If your role is critical to the point that your absence could jeopardise the business’s survival, key person insurance is advisable.
Business Structure and Size: Small businesses or startups that rely heavily on one or two individuals can benefit significantly from key person insurance.
Case Study: Evaluating Insurance Options for a Sole Business Owner
Background & Situation Analysis:
Lucas, the sole owner of his business, is evaluating his insurance options. Initially considering key person insurance, he faces unique challenges due to his sole ownership status.
Firstly, we reviewed key person insurance and life insurance options with Lucas, highlighting the following implications:
Key Person Insurance
Beneficiary Issues: Since Lucas is the sole owner, there is no business partner to take over operations if he passes away. Thus, the benefit from a key person insurance policy would be paid to the company.
Access to Funds: Upon Lucas’ death, the lump sum payout would go to the company. His wife, Amanda, would then face the complex and time-consuming process of liquidating the company to access these funds, a process that could take many months due to legal and probate proceedings.
Tax Implications: If Lucas claims relief against corporation tax on the key person insurance premium, any benefits would be taxed at 12.5% upon his passing.
Life Insurance:
Direct Payment: A life insurance policy would be paid out directly to Amanda. This would avoid the need to deal with company assets and liquidation processes.
Access to Funds: Once a life insurance claim is approved, the payout process is typically quick, usually completed within a couple of months. This immediate access to funds is crucial for meeting living expenses and other financial needs without delay.
Advised Solution:
Considering Lucas’s sole ownership and his wife’s immediate financial needs should anything happen to him, life insurance provides a straightforward and more effective solution.
The benefits of life insurance benefits, including a faster payout process and the elimination of the need to handle business liquidation, make it the preferred choice. o
This ensures that Amanda can quickly receive financial support, providing peace of mind and stability in a difficult time.
We recommended that Lucas secure dual life insurance with an added Serious Illness cover to ensure protection up to the age of 74.
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Choosing the right protection for yourself or your business can be complex and overwhelming. However, we’re here to provide the guidance you need and to highlight implications you may not have considered.
Our financial advisors at True Wealth will evaluate your unique circumstances to help you make informed decisions that support both your personal well-being and business stability.
We are also experts in personal and business protection, savings and investments, pension tracing, personal and business financial planning, mortgages, and wealth management and extraction.
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All our content has been written or overseen by a qualified financial advisor. However, you should always seek individual financial advice for your unique circumstances.
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