If given the choice, I think most business owners would rather discuss…well…just about anything other than life insurance. Who wants to think about insuring the life of a key person in your business? Or your own? But if you love your business, care about your employees and want to protect your business partners, then you should be thinking about key man insurance. Now … while you still can.
Most business owners buy key person insurance at some point in their career. This is a special type of life insurance that helps your company overcome the loss of the company’s most valuable employee… which is probably YOU!
[Note: Don’t confuse this with a policy to fund your buy-sell agreement, which we have written about before. A key-man insurance policy is not typically used by the company (or your partner) to buy out your share of the company.]
Getting the right deal can be tricky, however, even for an experienced agent. So let’s take a careful look at the kinds of policies you’ll want and the ways to avoid getting ripped off.
What to Ask for
Key person insurance works best with either a whole life or universal life insurance policy. Both of these are called “cash value insurance” policies – meaning that your company receives both a death benefit and a cash value reserve amount that can be used any time (and for any reason) during your life. Great, right? You don’t have to die!
While term insurance can be used, it comes with risks. Most states don’t allow policies on people over age 80 or 85, and normally there is no cash value to a term policy. This is a lose-lose: if you no longer need the policy, there’s nothing to withdraw… and if you live past 85, there’s no payment to help replace you. Either result is a bad deal.
Make Your Policy Fit Your Circumstances
Cash value policies are not all the same. You can pick a policy that emphasizes a high death benefit or a policy that emphasizes a high cash value amount. If you plan to die at your desk and really want to leave in style, go for a large death benefit. If you plan to retire or close the business in the next 10 years, think about accumulating a larger cash value in the policy — that way you can withdraw the value without actually, uh, dying.
- For the larger death benefit, purchase something called a “straight whole life” or “ordinary whole life.” A universal life policy with secondary guarantees or “guaranteed universal life” policy also works very well. Ask your agent about this helpful twist.
- If you’d rather accumulate some cash value (while still getting a decent death benefit of course), choose a “participating high cash value whole life policy.” These policies are sometimes referred to as “10 pay whole life” or “20-pay whole life,” and they pay dividends that help accelerate the cash value growth as well as the death benefit. (NOTE: for universal life policies, be sure you get a “minimum death benefit/maximum cash value” schedule. This minimizes the costs of the insurance while maximizing the cash value.)
Avoid Being Ripped Off
While most insurance agents are honest and decent people, there are always a few bad apples in the industry. Sadly, the number of dishonest (or just plain ignorant) agents seems to be growing. Protect yourself with these simple tips:
- Ask about commissions: If you are purchasing a policy to maximize cash value, the agent’s commission should almost never be more than 50 percent of the first year’s premium. Forty percent or less is standard. For maximum death benefit policies, a reasonable commission for the agent is 90 or 100 percent of the first year premium. Anything over these amounts should be considered an “expensive” policy.
- Budget more: When purchasing universal life, it’s always a good idea to pay more than the listed target premium in your policy’s illustration and contract, regardless of your company’s goal for the policy. The target premium is the minimum premium required to make the contract work. Never assume the minimum will be sufficient.
- Don’t be fooled by quotes. While most insurance agents will tell you to obtain several quotes, quotes can be highly misleading if you’re only looking at the “illustrated” rates for the policy. Agents love to show you the these, but an illustrated rate only show you how the policy works, not how it will actually perform. Instead, compare two quotes by looking for a table in the illustration called the “cost surrender index.” This will tell you how much you’re paying per $1,000 of insurance.
When you – or your key persons – die, a key-person insurance policy will pay off and the proceeds will go to your company. The proceeds are tax-free because the premiums are non-deductible (you paid taxes on the premiums all along, so you won’t pay on the benefit).
The pay-out can be used for any purpose, but of course the whole point was to find a replacement CEO and train her to fill your shoes – as big as they might be. Your staff or heirs could also use the money to wind-down the business, bonus employees, or maybe just throw a giant party. You can’t control how they will spend it, but you can make it possible for those left to continue the business without you.
Dedicated to your (endless) profits, David Lewis
Guest writer David Lewis is the founder and owner of Monegenix™, a financial services company located in Raleigh, NC, as well as a member of the International Association of Registered Financial Consultants. He has appeared as a featured writer in The Register, NuWire Investor, and has written hundreds of business and personal finance articles for private law firms, accountants, and Chron.com – the online iteration of the Houston Chronicle. His company’s website, Monegenix.com, helps business owners, independent contractors, and the self-employed solve both simple and complex financial planning problems.