Key person insurance | Is it what you need?

Over the years I have spoken to many clients who initially thought they needed key person insurance but, in the end, realised that they needed a shareholder protection policy.

Let’s look at both policy types and see which is the best for each purpose.

Key person insurance

A key person policy, also known as a key man policy in the past, is a life insurance policy taken out on the life of a key member of the team. This could be a top salesman, company director, manager, or anyone else who wouldn’t be easily replaceable.

In the event of their death, the policy pays a lump sum to the company. The business then uses this money to smooth out any loss of earnings until this key person can be replaced.

They are excellent policies that can make a massive difference to a business at a difficult time.

The business pays the premiums, and the life assured does not normally pay benefit in kind tax. Premiums can qualify for corporation tax relief where HMRC’s wholly and exclusively test is met. The tax treatment of the premiums and any payout are linked, so the position should be confirmed with your adviser and accountant when the cover is set up.

Shareholder protection policy

Often confused with key person insurance, shareholder protection is a life policy taken out on the lives of shareholders in a company. In the event of the death of an insured shareholder, the policy pays a lump sum for the benefit of the surviving shareholders, usually through a trust.

A cross option agreement is usually put in place alongside the policies. It gives the surviving shareholders the option to buy the deceased shareholder’s shares and the estate the option to sell them, with the insurance money used to pay for the shares.

The result is that the surviving shareholder or shareholders take complete control of the company, and the deceased shareholder’s family is paid fair value for the shares.

In many arrangements the business pays the premiums. Whether there is any benefit in kind or P11D reporting depends on how the arrangement is structured, so it should be confirmed with your adviser and accountant.

Can key person be used as shareholder protection?

Technically, yes. Both are life insurance contracts, and the premiums will be identical on a like-for-like basis. However, the cross option agreement is what ties a shareholder protection arrangement together. Without one, there is no agreed mechanism for the shares to change hands, and the surviving shareholders would be under no obligation to use the money to buy the shares, which could cause a problem for the deceased shareholder’s family.

Also, there might be a dispute about what the fair value of the shares is, with the family of the deceased thinking they are worth more than they are, which could potentially cause problems for the surviving shareholders.

As premiums are the same for both, it’s always better to apply for the correct policy and ensure the best cover possible.

Summary

If you are wondering which policy is right for you, contact our team. We work with many other businesses facing the same challenges as you and are best placed to help.

We can quote you in as little as 60 seconds. We know time is limited, so we won’t give you the big pitch either. We’ll just answer your questions and let you know what to do next.

Written by

Alex Ogden DipFA | Director | Executive Life

Alex Ogden DipFA holds the Level 4 Diploma for Financial Advisers (DipFA) awarded by the London Institute of Banking & Finance (LIBF), the FCA's benchmark qualification for retail investment advisers. He is authorised by the FCA, Ref: AJO01072. View the FCA register entry.

Tax rates and thresholds are subject to change.