A Lesson on Key Person Life Insurance

Posted by Ralph Sklar @ 1:45pm on May 30, 2017

I once kept an office above a large restaurant in Oakland’s Jack London Square. The restaurant was started by two people, and for the sake of privacy, I am calling them Jim and Sam. Jim was a successful restauranteur who had recently sold another restaurant. Sam knew nothing about running a restaurant, but had money to invest.

One day I stopped by for lunch and learned of a terrible tragedy. The previous day, business was bad, and Jim said, ‘I am going to go home and kill myself.’ Nobody took him seriously, but that’s exactly what he did. Unfortunately, he was uninsured which created a double tragedy. The surviving partner, Sam, worked himself to exhaustion trying to run the business on his own, but he ended up physically and financially wiped out. Not only did Sam lose the money that he had invested, but he was on the hook for loans, equipment leases, salaries, taxes, and years of future rent.

A funny thing about some smaller business owners is that they will insure every trash can for its full replacement cost, and not insure their key profit makers. But the people who have the company’s relationships and intellectual property between their ears, can and should be insured to the extent that the business would suffer without them. Most of your company’s assets never leave the building, but employees go home every night. Sometimes they travel on dangerous roads, sometimes they participate in dangerous sports, sometimes they get sick. And a surprising number of times they take their own lives. This is why large companies like General Electric and Bank of America routinely insure their ‘Key people,’ and why many years ago the Supreme Court of the United States recognized the need for companies to insure their ‘human capital.’

Key person insurance is sometimes confused with Buy/Sell insurance. But they are completely different things. Money received from Buy/Sell insurance is destined to leave the firm. Money received under a Key Person policy stays with the firm and provides funds to help the company until they adjust to their new reality.

Can Key Person Life Insurance be valuable even with employees who live to retirement? Yes it can. It can help to recruit, retain, and reward your team members with enhanced retirement benefits if they stay with you long enough. And it can be very tax efficient. But… this type of Life Insurance must be done correctly, otherwise the death benefit can become taxable. At Silver Transitions, we focus first on what can go wrong, but then we try to improve the things that go right. Key Person Life Insurance lets us do both at the same time.