Business owners are often confused on the names, as well as the types, and uses of business life insurance. In many cases, business owners will refer to “key-man life insurance,” but they are actually referring to insurance for the funding of a buy-sell agreement. I will try to clarify in simple terms the differences.
Very simply stated, a key-man policy is a policy that is owned by the business on the life of a key person. Many times, this key person could be an owner or one of the owners. However, a key person does not have to be an owner. They could be anyone in a position whereby the business would suffer substantially and financially with the loss of that person, hence the term “key-person.”
On the other hand, a policy for the purpose of funding a buy-sell agreement is called buy-sell insurance or a buy-sell policy. Now this is not necessarily a different type of policy than a key-man policy, it is just that the purpose of the policy is different.
A policy for the purposes of funding a buy-sell agreement is usually owned by the partners individually. Many times, with three or more partners or owners, the buy-sell policy is generally going to be owned by the business itself.
Since there are potentially adverse future tax ramifications to having the entity own the policy, you will want to make sure your advisor and CPA have discussed the best solution for your individual situation.
In summary, if you are a business owner and think you have the proper type of life insurance, it would be wise to have someone double check so as not to leave you or the business exposed to future problems.
Last but not least, we’ll wrap up the Business Owner Blind Spots series with #10 of the 10 Most Common Business Owner Blind Spots, Accelerating Mortgage Debt. Stay tuned!