For example, the remaining shareholders may not have the means to buy the shares back, and selling the shares becomes problematic.
This is why a term or a whole-of-life policy can be used to direct the shares to the remaining shareholders and provide the family with a cash lump sum.
A relevant life plan can provide individual death-in-service cover for the benefit of an employee’s family.
According to Legal & General, it pays a lump-sum to the employee's family if they die or are diagnosed with a terminal illness with a life expectancy of less than 12 months.
While it can be relatively simple and cost-effective to set up, it can also prove to be beneficial for families.
How key person cover works
But for the purposes of this feature, key person cover or key person replacement cover (sometimes still called key man cover) is the focus.
This is widely used to cover the costs incurred by a company where a key person is unable to work.
According to Neil Liversidge, principal of West Riding Personal Financial Solutions, key person cover is fundamental for any business owner and he talks to all his employer clients about it.
He comments: “Any company who bins their key person cover has not got their priorities right. Either that or, if they did have their priorities right and they are still having to bin it, they are moribund now regardless.”
Insurance broker Drewberry puts it quite simply: "Key man insurance provides a cash lump sum if someone crucial to your company’s ongoing success passes away. It can be used for:
- Providing a buffer against loss of profits.
- Protecting an outstanding loan, investment or funding.
- Covering the cost of recruiting and training a replacement.
- Any other reason your business sees fit to use it."
Because it is there to protect your clients' business (and your own as an adviser), premiums on key person insurance is typically eligible for corporation tax relief.
According to Drewberry: "When a business takes out key man insurance to cover an employee, premiums are typically a tax-deductible business expense eligible for corporation tax relief.
"This is because the payout is not for the benefit of the employee but for the business to make up for the loss of that key person."
That said, because the benefit usually counts as a trading receipt, it will therefore still be taxable.
Drewberry advises to gross up the payout to ensure the "net figure you receive post-tax still meets your needs".
HM Revenue & Customs' Business Income Manual goes into more detail on the purpose and conditions of key person cover.
It states: "An employer may take out in their own favour a policy insuring against loss of profits resulting from the death, critical illness, sickness, accident or injury of an employee, director or other ‘key person’.
