When a business loses a key person, several things can happen. First and foremost, the business is disrupted as the owners try to assess what has happened and develop a plan of action. This disruption usually causes a drop in sales as the business focus is diffused. As well, sales that have already been made may not be deliverable or may be questionable, causing clients to go elsewhere. Creditors may become concerned and force the company to liquidate assets to pay back loans or, possibly, put it into receivership. Finally, even if the business is able to survive all these factors, it still must replace the skills that were lost, if possible. 

 

Fortunately, the possibility of death or disability of a key person is a contingency that can be insured. Businesses can purchase corporate-owned life insurance on the lives of their key people. If one of these key people dies, the business receives a tax-free death benefit which it can use to meet expenses and repay debts, thereby easing the fears of creditors. The money can also be used as a reserve against the drop in revenue that may occur while the company goes through a period of transition. Finally, the money can be used to pay the costs of replacing the lost skills. 

 

A side benefit for private companies is that the life insurance proceeds can be paid out as tax-free dividends to the owners once the business has recovered. Funds can also be used to provide a $10,000 tax-free death benefit to the spouse of the deceased. As well, an opportunity exists for the key person to take advantage of the tax-deferral capabilities of certain life insurance policies through split dollar coverage. 

Disability insurance is also available on key people. The company owns the plan and is the beneficiary of the proceeds. The proceeds, of course, can be used for all the same purposes as proceeds from life insurance plans. The only difference is that the disability insurance proceeds cannot be paid out as tax-free dividends to the owners of the business, nor can they be paid tax-free to disabled employees.

 

Read More: Globe & Mail Article of Interest