Every business relies on its people – and in many cases, the success of a business hinges on just a handful of them. So what would happen if one of your key people were suddenly unable to work due to illness, injury, or death? Key person insurance is a tailored solution that helps protect Australian businesses from financial disruption in these situations.
Let’s explore what key person insurance is, what it covers, how tax treatment works, and the key benefits it can offer to business owners. We’ll also explain how the team at Priority Advisory Group can help you evaluate whether this type of cover is right for your circumstances.
What Is Key Person Insurance – And Why Does It Matter?
Key person insurance is a type of life insurance that a business takes out on the life of an individual who is vital to the company’s ongoing operations or profitability. In the event that this person passes away or suffers a critical illness, the policy pays a benefit to the business – not the individual or their family.
These individuals might be owners, founders, sales managers, technical experts, or directors. In short, anyone whose skills, experience, or connections are integral to the business. Without them, cash flow might drop, operations could slow, or valuable relationships may be lost. The proceeds of a key person insurance policy can help cover recruitment and training costs, stabilise income, repay business debts, or buy out shares – all depending on how the policy is structured.
Tax Treatment of Key Person Insurance
Key person insurance can serve two distinct purposes: revenue protection and capital protection. It’s important to define which purpose the policy is intended for, as this has implications for tax deductibility.
- Revenue Purpose: If the policy is meant to replace income lost due to the absence of a key person (e.g. sales, productivity), then premiums are generally tax deductible. However, any payout received in the event of a claim are treated as taxable income.
- Capital Purpose: If the goal is to protect the business’s capital base – such as paying out debts, loans guaranteed by the key person, or compensating for loss of goodwill – then premiums are not tax deductible, but claim proceeds are typically not taxable, though Capital Gains Tax (CGT) may apply.
If you wanted insurance for both of these purposes, you could choose to take out a separate policy for each, or a single policy to cover both. A single policy affords you greater flexibility if revenue and capital needs fluctuate. However, the need to document which portion of your key person insurance policy premium relates to revenue or capital, having everything on the same policy may be more of a burden to maintain. Getting this balance right is critical, which is why seeking expert advice when establishing a policy is so important.
Benefits of Key Person Insurance – A Business Lifeline in Crisis
The unexpected loss of a key person can destabilise even the most robust business. Having key person insurance in place gives business owners a financial cushion and peace of mind.
Here are some of the key benefits:
- Stabilise revenue by offsetting lost income
- Cover recruitment and training costs for replacements
- Repay business loans or protect personally guaranteed debt
- Safeguard equity ownership in the event of a shareholder’s passing
- Avoid disruption to relationships with financiers, customers, or suppliers
In essence, it helps maintain business continuity when it matters most. It also provides an opportunity to restructure or adapt the business with less financial pressure.
Is It Right for You? Determining the Right Cover
There’s no one-size-fits-all approach to key person insurance. The cost of cover depends on the person insured, their role, health, the level of cover needed, and the policy structure.
Some things to consider when determining appropriate cover include:
- The individual’s contribution to revenue or profits
- The cost of replacing them
- Whether they’ve guaranteed business debts
- The long-term plans for the business
It’s also worth noting that one policy can cover multiple people, or you might choose separate policies for different revenue and capital protection needs. Either way, proper documentation and ongoing review are essential – especially for tax purposes.
Advice You Can Trust, Protection Your Business Deserves
No one likes to imagine the worst-case scenario – but being unprepared for it could cost your business dearly. Key person insurance can be a powerful tool in managing business risk, and ensuring your business continues to thrive, even when faced with adversity.
At Priority Advisory Group, our experienced Life Risk Insurance advisers take the time to understand your business, your people, and your goals. We’ll assess whether key person insurance is appropriate for your situation and recommend a strategy that fits – including help with tax structure, ownership considerations, and ongoing reviews. Call 1300 349 188 or get in touch with us to start the conversation.