Key Person Protection
INSTRUCTION TO USER – The following section has been designed for inclusion within a report generated by the PPOL suitability report writing solution. You will need to use the PPOL software to create a report containing an Introduction section and a standard Protection Recommendation for the underlying product you are recommending (e.g. level term assurance, whole of life etc) in the usual way. Once you have downloaded the report created via PPOL to Word, insert the protection recommendation within the text at the point indicated below and simply edit the resultant section to reflect your individual requirements.
The text has been colour coded to aid with your understanding. Where the text is highlighted in blue this tends to suggest that the text may not be appropriate in all instances, and you may need to delete some or all of it. Where the text is highlighted in red, this will require your input.
Most businesses will have implemented arrangements to cater for the retirement of their key individuals, and some may also have considered their business succession. Fewer will have considered the effects of the loss of a key individual through illness or death.
The consequences of losing a “key” employee are obvious to state but are not always considered. Such an event could lead to the loss of key contracts, sales or profits; and the business could face difficulties in terms of raising capital, retaining finance or re-paying loans.
I understand you are keen to provide protection for the following “key” employees:
Name of Employee / PositionThere is no set formula for calculating the monetary value of a key person to the business. The financial loss to the company on the death of a key employee will depend upon a number of factors including the following:
· The level of recent and expected profits
· The effect on profits if the key person were to die, or become disabled
· The cost of recruiting and training a replacement, and the loss of profits during that period
· Loans that could be recalled on the key person’s death or disability
· The length of time before the key person is due to retire
Multiple of Profits
This is the primary method of calculating the key person’s worth. The normal multiples are:
· 2 x gross profit or 5 x net profit
The profit may need to be split where there is more than one key person. Higher multiples may be justified for a rapidly expanding business.
I have applied a multiple of <INSERT> representing <INSERT> profit. To this end, the maximum cover required is £<INSERT>
Multiple of Salary
Using this approach, the key person’s salary (including any benefits) is multiplied by a factor usually between five and ten. This may be increased to fifteen times in exceptional circumstances, if, for example, the key person is relatively young.
I confirm the salary for the key individual for the last tax year was as follows:
Remuneration / Benefits / AmountBasic Salary / £
Dividends / £
Car / £
Health Insurance / £
Pension / £
Other / £
Total / £
I have applied a multiple of <INSERT>. To this end, the maximum cover required is £<INSERT>.
I do stress that this is a simple way of calculating the level of cover required, but it has its drawbacks – A person’s salary may not always reflect their real value to a business, neither does it take account of the individual’s time until retirement.
Proportion of Salary Roll
This formula takes account of the key person’s salary, annual profit or turnover and the time it would take to replace them. The formula usually used is as follows:
Key person’s salary x profit or turnover (in last year) x No of years to replace key person
Total salary bill
If profits are expected to increase in the future, we need to ensure that the level of cover takes account of this fact.
The profit figure can be either the gross or net profit. The net profit is a good reflection of the performance of the business, but will not always allow for some of the fixed expenditure (e.g. rents, rates, salaries etc), which still have to be paid after the key person’s death. The gross profit can give a better reflection of the business profit lost on their death.
To this end, I have calculated the amount of cover required to be as follows:
Key person = <Insert Name>
Key person’s salary x profit or turnover (in last year) x No of years = <INSERT>
Total salary bill
To help reduce the loss that the “key” employee makes to the stability, profitability or success of the business, I have recommended that you establish suitable protection to provide a cash lump sum in the event of the death, or earlier diagnosis of a critical illness, of the “key” employee(s).
Life Insurance Recommendation
INSTRUCTION TO USER - INSERT APPROPRIATE PROTECTION PRODUCT RECOMMENDATION HERE
<INSERT FOR COMPANY OR LLP PARTNERSHIP OR EMPLOYEE OF A SOLE TRADER
I have recommended that the policy be set-up on the “life of another” basis with <INSERT name of KEY PERSON as the life assured, and the company / LLP partnership as the owners and ultimate beneficiaries of the policy.
<INSERT FOR PARTNERSHIP OR SOLE TRADER>
I have recommended that the policy be set-up on an own life basis in trust with <INSERT name of KEY PERSON as the life assured, and the owner.
INSERT FOR PARTNERSHIP
Policy to be written into a business trust with remaining partners as beneficiaries.
INSERT FOR SOLE TRADER
Policy to be written into a gift trust with family as beneficiaries.
MANDATORY INSERT
Tax Implications
If the premiums qualify for tax relief, the general position is that any benefit paid out is likely to be treated as a trading receipt and subject to tax at the appropriate rate (or vice versa if tax relief is not granted). For further clarification of this important area, I refer you to the technical notes that follow.
Notes on Financial Products - Key Person
Limited Company
As a company has its own legal identity then the company will be both the applicant and the plan owner. The life assured will be the key person. Authorised signatories of the company will sign on behalf of the company, and the key person will also sign as life assured. There is no need for a trust to be used. Instead, the company owns the plan, pays the premiums and receives the Proceeds.
If two equal key people need protecting, i.e. two 50% shareholding directors, a single owner joint life assured plan can be effected and critical illness can be included
Partnerships
In the case of a partnership in England, Wales and Northern Ireland, a partnership is not a separate legal entity in its own right and therefore cannot take out a key person plan. There is however a solution to this problem. The key person could insure their own life and place the plan under trust for the benefit of all the partners in the business (a business trust can be provided for this purpose).
In Scotland, this is not an issue, as a Scottish partnership is a separate legal entity. Therefore the plan can be set up as life of another with the business as both owner and the recipient of any benefits.
Limited Liability Partnerships
A limited liability partnership (LLP) is halfway between a limited company and a partnership. It is a legal entity in its own right and it is completely separate from its members. It is registered with the Registrar of Companies and it must follow regimes for accounting, disclosure of financial information and insolvency almost identical to limited companies. The liability of the partners is limited to the amount subscribed for the LLP. However, for taxation purposes, the individual partners are treated as if they are self-employed individuals, just as if the LLP was a partnership.
If an LLP wishes to take out a key person plan, this would normally be written on a life of another basis with the LLP owning the plan.
Taxation
There is no direct legislation concerning the taxation of “key person” insurance. Guidelines were set out in the 1940’s by Sir John Anderson, stating that tax relief would be granted on the premium and the proceeds taxed as a trading receipt if:
· The sole relationship between the life assured and the policy owner is that of employee and employer
· The aim of the cover is to insure against loss of profit due to loss of services of the employee
· It is an annual or short term insurance
If the employee is also a significant shareholder, tax relief is unlikely to be granted on the premiums as the policy is partly for the assured’s own benefit.
The term of the policy was never defined but it is generally thought to be around five years. However, the Revenue will look at each case individually before making a final decision.
A business cannot choose not to claim relief on the premiums in the belief that the proceeds will be tax free. The tax position of the premiums and any proceeds is granted and will very much depend on the individual facts of each case and the practice of the local inspector of taxes. It is strongly recommended that the tax treatment of the premiums should be confirmed with your local inspector of taxes before inception of the policy. However, the inspector is not likely to decide on the tax treatment of any proceeds until a claim arises.
What Happens to the Cover if the Key Person Leaves?
In many instances, the company will take out key person cover and that key person will subsequently leave or retire from the company before the plan has paid out. The company may then decide to cancel the plan, as it is not then required. Alternatively, consideration could be given to gifting the ownership of the plan to that departing key person, with the individual then taking on the responsibility of paying the premiums.
If however the assignment occurs in the same tax year in which the individual leaves or retires, then the benefit in kind legislation will tax the individual on a sum equal to the cost of the benefit, that is, the total premiums paid at the date of transfer. This could be quite costly, particularly where the plan has been running for a considerable time. The employer however, can easily circumvent this potential liability by waiting until the following tax year before assigning the plan to the individual who had left or retired (the employer having paid the premiums in the meantime). In this case, the benefit in kind legislation cannot apply. Instead,
the termination of employment legislation applies such that the tax liability will be calculated on
the realisable value of the plan. Typically this will be the surrender value, which could be low or even zero if term assurance.
Critical illness is not a chargeable event for tax purposes. In all other respects, the tax treatment in relation to premiums and proceeds will be the same as for life plans.
The assumptions and workings of your business shortfall analysis have been based on our current understanding of law and HM Revenue & Customs practice. Although every effort has been made to ensure its accuracy, no responsibility can be taken for our interpretation of law or future changes in law or practice.
I strongly recommend that we review your business protection on a regular basis to ensure your business protection continues to reflect your needs and objectives.