Know Your Money with Bronwyn Waner and Craig Finch
Know Your Money with Bronwyn Waner and Craig Finch
135. Protecting Your Business: The Key Person Insurance Guide
Protecting your business from unexpected tragedy is something most entrepreneurs don't want to think about, but ignoring this crucial planning could cost you everything you've built.
Key man insurance represents one of the most important protection strategies for small to medium businesses, yet it remains widely misunderstood and underutilized. We break down exactly how this vital coverage works - when a company takes out insurance on an essential team member whose absence would significantly impact operations, the policy provides financial resources to weather the storm if that person dies or becomes permanently disabled.
But the devil is in the details. The tax implications alone require careful consideration - should you make premiums tax-deductible and accept a taxable payout, or forgo the deduction for a tax-free benefit? We walk through the four critical requirements that determine whether the policy becomes part of the insured's estate (with potential estate duty liability), a particular concern for family businesses where relatives might benefit indirectly. Understanding these nuances could save your company from unexpected financial burdens during an already difficult transition.
The podcast explores practical questions too: How do insurers determine who qualifies as a "key person"? What documentation is needed? How much coverage is appropriate? Whether you're thinking about your star salesperson, technical genius, or the founder who holds all the client relationships, this episode provides essential guidance on protecting your company's future. Don't wait until it's too late - proper planning with professional guidance ensures both your business and the families who depend on it remain secure no matter what happens.
Please subscribe to our podcast or have a look at our website
www.growthfp.co.za
Hello everybody, welcome to Know your Money. I'm Bronwyn Wehner.
Speaker 2:And I'm Craig Finch and we are from Growth Financial Planning. We hope you enjoy our podcast.
Speaker 3:Hello everybody, Bronwyn today all the books on the table getting really technical. Here you enjoy our podcast.
Speaker 1:There is absolutely a way you're going to understand it, because I'm going to explain it to you in the best simple way possible, but by using my notes.
Speaker 2:So I understand it, bron, that a key man policy. So let's take Rogue Media, your company. You've got a partner, you've got premises, you've got a whole business running here, fantastic studios, and you're a key person in this business. So if Warren isn't here, the business is in trouble. I think so.
Speaker 2:So the company Rogue Media Pty Ltd could take a policy on your life. They own the policy. So Rogue Media own the policy and if an unforeseen horrible thing happens and Warren happens to leave the earth or happens to be unable to work for the rest of your life, so death and permanent disability, the policy will pay to rogue media and they would use those proceeds to replace you. So there would be a business interruption scenario where the studio wouldn't be booked because they need to find somebody else that could fulfill your role and it might take a few months to do that and it's going to cost the business money and they need some working capital to get somebody in place and they've got to pay the lease, the rent, etc. So they use those funds to pay for the loss of you.
Speaker 2:So a key person in the business. So you can be an, a co-owner and a key person, or you can have a situation where you don't you're not. You're not a owner, you're working for a company and you're the super salesman there and if you pass away or become permanently disabled, that company is going to be affected by you not being there selling.
Speaker 3:Yes.
Speaker 2:So that company let's say it's a big steel company will affect the policy on their super salesman and if that person dies or becomes permanently disabled, the company gets the proceeds and they use that to replace that key person. That's why it's called key man assurance. Never heard of it. That's interesting. And it's not partnership insurance. We'll cover that in the next segment. This is key person assurance. Am I right, bronwyn, what I say there?
Speaker 1:You're absolutely right in describing that and I think you know. I went to some clients of mine the other day that own a business and they were talking about key man insurance and I thought it would be such a good topic to bring it up, because there are two important ones. One is key man and the other one is a buy and sell agreement, which is what Craig alluded to us discussing another time.
Speaker 2:The partner one yes.
Speaker 1:So the example of you is key. You know that if you're not here, it can't run like it's supposed to, because you've got….
Speaker 3:Yeah, I designed it. Yeah, Exactly.
Speaker 1:Yeah, you do. So I just wanted to maybe get into a little bit of the technical of each of these, because often people now are going to go run out and go and put this in place, but then there's implications to it if you don't do it the right way. So it can be deductible as an expense for the company.
Speaker 3:The policy cost the policy.
Speaker 1:cost can be, but you have to follow the four requirements set out by legislation.
Speaker 2:But, brian, just on that, if it gets deducted by the company, warren, and the policy pays out, that pays into the company and it will be taxed as well, correct?
Speaker 3:Yes, the payout will be then formed part of their tax obligation.
Speaker 2:It will be formed part of their income kind of They'll have to show in their balance sheets. If you're deducting the policy, the proceeds will be taxable.
Speaker 3:Understood, yeah that makes sense though. Yeah, because you've internalised it in the company.
Speaker 2:Yes, you can not deduct it as a company expense, and then the proceeds will be tax-free.
Speaker 3:Because any life policy will pay out tax-free, so you can still pay it from the company but not claim it as a tax expense. Yes, as long as you don't deduct it. As soon as you deduct it, then you Then it forms part of your tax obligation on the payout. Correct, understood, correct.
Speaker 2:Yes.
Speaker 1:So I mean I don't think I need to get into the technical what those four requirements.
Speaker 2:It's quite a thick book.
Speaker 1:Oh, it is very thick, but just understand that. If you do want it to be, you know I can try to do it as reasonable as possible.
Speaker 3:Do it in idiot language for me.
Speaker 1:Okay, let me try that. Yeah, maybe not that one.
Speaker 3:Yes, it's a bit not idiot language that so I I told you earlier about my, my, uh, my playing's around with chat gpt. Now, and that's what I have to say to sometimes I say I assume I'm a moron and re-explain what you just said yeah, because it is it's tough it's very technical so.
Speaker 1:So that's one side of it is the tax deductibility. Then the second part, which is quite important, is, if you have this key man policy in place, it can sometimes form part of your estate. So let's say, for example, this amount that it needs to be is 5 million Rand. Yes, okay, that 5 million Rand will go into your estate and the other topics that we've spoken about where there's estate duty.
Speaker 3:So it would then affect my wife.
Speaker 1:Yes.
Speaker 3:Even though the company was the one to do it, and it pays out to the company.
Speaker 1:Yes, because, remember, you get three and a half million free of estate duty. Yes, anything over and above that is estate dutiable. If you leave things to your wife, then it's free of estate duty. But this policy is going to have gone to the company.
Speaker 3:And is it become part of my estate because it's effectively replacing me?
Speaker 1:Yes, because it's you as a person. Yes, yeah, but there are four requirements that, if these four requirements are met, it doesn't form part of your estate. Okay, we need to know these ones. These ones are the ones that I think you really do need to know. Okay, so the first one is that the policy is not taken out by the deceased employee, so you don't take it out.
Speaker 3:My partner would take it out.
Speaker 2:Yes, the company still would take it out. You wouldn't take the company Rogue Media. Yeah, you are right, craig, sorry.
Speaker 3:But effectively I'm not the one who's making the call.
Speaker 2:You can't say no.
Speaker 3:It would come from another director.
Speaker 1:Absolutely. The second is that no premiums under the policy was paid by the deceased employee, so you cannot pay.
Speaker 2:Has to be paid by the company. Yes, rogue Media's bank account has to pay, okay.
Speaker 1:And where that can sometimes happen is I've got a policy in my name and I can't get life cover anymore. So I say, okay, well, you buy this policy from me and then that can be the policy. So I say, okay, well, you buy this policy from me and then that can be the policy, but I've paid some of those premiums.
Speaker 2:So if you cede that policy to the company, there's going to be a problem.
Speaker 1:There'll still be a state duty.
Speaker 3:A state duty will be paid, understood, yeah.
Speaker 1:Okay then number three no amount you're recoverable from the policy has or will be paid into the estate of the deceased. So, as Craig explained, the money gets paid to Rogue. Nothing goes to you or your beneficiaries. That one makes sense. Now this is the kicker, which is quite tough is no amount due or recoverable under the policy has been or will be used for the benefit of any relative?
Speaker 3:So Roe can't then give money to my relatives.
Speaker 1:So let me explain this one a little bit more. And it's to the third degree. So if a company is a family company, Right. There'll be a state duty.
Speaker 3:Okay, but this is not a family company.
Speaker 1:Yes, In your situation? Yes, but there's often these people where a dad starts a business and now his son comes in.
Speaker 3:It's John T and Sons.
Speaker 1:Yes.
Speaker 2:And they insure the son.
Speaker 1:And they insure the son and they think that the key man policy is now all sorted. And it's not to say don't have it, it just means you need to. Whatever the amount is you want to cover, you need to. Whatever the amount is you want to cover, you need to. Whatever the amount is you want to provide, you provide just that little bit more for the estate duty that would be liable.
Speaker 3:Right, okay.
Speaker 1:So it's not exactly right. But just for numbers, let's say it's a million rand, do 1.2 million. 1.2 is not the exact right number because of estate duty, but just in the sense.
Speaker 3:Can I ask a question? What's the criteria for someone to be deemed a key person?
Speaker 2:Well, it's normally obvious. I mean like you would be obvious a key man here.
Speaker 3:But let's you know you couldn't you wouldn't If, for example, my business partner he is key to me, but he's not key in the everyday runnings of this business. Yes, so there you are. That answers your question.
Speaker 2:So then it couldn't be part, even though he's like you could, you could, but I mean you are the, so the buy and sell is another story which we'll talk about in another time.
Speaker 1:That's a partnership there. So the key person is normally it's clearly the best salesman or the technical director, but if that person's gone, the income that comes into this company can't come in.
Speaker 3:So the company will fiscally suffer when that person's gone?
Speaker 2:Yeah, like Red Bull Racing with Adrian Newey. He's a key person there and you know what I mean. They should have insured his life for millions because he's a key person in that.
Speaker 3:I suppose, then, all the Formula One teams do this with the drivers, don't they?
Speaker 2:Yeah, that's another. So it's normally clear you can really see where there's a key person, you might have the best chef in the world in a restaurant and that chef is the key person.
Speaker 3:When you try and take out the policy, they will do their due diligence and go. That's not a key person.
Speaker 2:Yeah, they won't refuse the policy.
Speaker 3:Once they've accepted the policy, they do have to pay out when that person dies. Oh yeah, no, no, no, when that person dies.
Speaker 2:Oh yeah, no, no, no, they'll underwrite. Any life company will underwrite it Underwrite yes, yes underwrite the risk? How much cover? Because you also can't put whatever you like in.
Speaker 3:Well, that's. What's funny is like somebody just wanted to say like okay, the guy who makes the coffee, he's key yeah.
Speaker 2:There's 250 million on him. Underwrite that policy Understood okay, and one of the criteria will be financial.
Speaker 1:Yeah, they take the financials, the finances into consideration.
Speaker 2:The other one is obviously the person's health, and the finances would play a big part on how much cover you can affect on that person. Okay, and that's yeah, but I think what we try to say is that a lot of companies smaller businesses, smaller medium businesses have key people in there. They do die. They do cost the company a lot of heartache nevermind the heartache, but the financial loss is huge. You can insure a key person in your company. Look at that seriously and also get your financial planner involved to make sure that the agreements are in place properly, that it's structured correctly, the cover's properly put in place, and make sure that the family or the person who's the key person, their estate, is also looked at to make sure it's a proper structure. It's a bigger picture than just the company.
Speaker 3:Yeah, it's got to go to. Yeah, exactly, and I just wanted to say the who.
Speaker 1:How does it count as a family company? So it's not to say that you can't have this policy. It's just, if you do, and it is a family company, put 20 more for the estate duty. Okay, so it goes to the third degree. So it's it's constituted as a family company if it's mother or father, grandmother and grandfather, brothers and sisters and their spouses, nieces and nephews and their spouses, uncles and aunts, sons and daughters, grandchildren and their spouses.
Speaker 3:But not the grandchildren's children. No, no, no.
Speaker 1:Yes, so then it's not a family company. So it's quite broad. No, no, no, yes, so then it's not a family company, so it's quite broad, but just to understand that, because otherwise there's this huge implication on that person's estate planning, which you don't want to do.
Speaker 2:Yeah, interesting.
Speaker 1:Good, that make sense. Was it dumbed down enough?
Speaker 3:Well, with me traveling soon, I think we've got to do that, yeah.
Speaker 1:Yeah, for sure.
Speaker 3:It's so important. Got to know Joseph's going to be okay guys.
Speaker 1:Yeah.
Speaker 2:Exactly. Thanks everybody.
Speaker 1:Thanks so much.
Speaker 2:Look forward to the next episode, thank you. Thank you for listening. If you have enjoyed this podcast and would like to subscribe, please visit our website, wwwgrowthfpcoza. The information we have provided in this podcast is our personal opinion. For more detailed information, please discuss your financial situation with a financial planner.