‘Key Person Insurance’ for Small Business Owners
Written by Steve Landers & Dylan Sinclair
Introduction
As the backbone of the Australian economy, small businesses play a crucial role in driving growth and innovation. However, navigating the complex landscape of insurance can be daunting for these entrepreneurs. In this article we discuss some of the key person risks of a business and how you might decide to mitigate them.
Small businesses in Australia are predominately reliant on a handful of ‘key’ persons, who drive the revenue, run operations and own the business equity. If these people are unable to be at work due to an untimely death, injury or illness, the business will likely suffer negative impacts. These risks are either categorised as:
Revenue – where there are day-to-day impacts on revenue, operations and profit. In this situation additional insurance ‘revenue’ may be required to allow for the hiring of a replacement or to compensate for revenue loss.
Capital – here there might be a requirement for the remaining shareholders to buy-out the equity of the exiting partner and thus they will need funds to do so, or simply they may need a lump sum to clear off external or internal debts.
While these insurance policies are created for the sake of the business itself, they are still underwritten and priced based on the individual’s age, gender, occupational duties and health. The types of policies that you can choose align with those intended for ‘personal’ use, including:
Life
Total and Permanent Disability
Trauma
Income Protection
Some important aspects of these policies are shown below:
1. Revenue Purpose Key Person Insurance:
Tax Deductibility of Premiums: When the key person insurance serves a revenue purpose, the premiums paid are tax deductible. This means that the business can claim these premiums as an expense on their tax return.
Assessable Proceeds: However, in the event of a claim (such as the death, disability, or serious illness of the key person), the insurance proceeds received are recognised as assessable income. This means that they are subject to taxation.
Considerations: Tax implications must be taken into account, and the insurance coverage amount may need to be adjusted to account for potential tax deductions.
2. Capital Purpose Key Person Insurance:
Tax Treatment of Premiums: For insurance taken out for capital purposes, the premiums are generally not tax-deductible. This is because they are considered to be more aligned with capital rather than an operational expense, and thus cannot be claimed as a business expense.
Non-Taxable Benefits: However, the benefits (proceeds) received from capital key person insurance are generally not subject to capital gains tax (CGT), depending on the policy owner. This is because they are considered as compensation for the loss of a capital asset rather than a profit generated from the sale or transfer of assets. However, please note that in some situations the structure of the policy and its owner will create CGT implications.
Considerations: The structuring of these policies is important as the policy owner will be the one to define whether tax is payable or not in certain scenarios. For example, a company may pay the premium for a policy, and as such it would make sense that they are the policy owner, however, this may then mean that capital gains tax is applicable. In this situation, the life that is insured may in fact be the policy owner, but as the company is paying the premiums, there needs to be consideration in the shareholders agreement as to the treatment of the benefit. Otherwise, similar to Revenue Purpose policies, the benefit amount might need to be adjusted to account for the expected tax liability.
Conclusion
Small business owners in Australia face both risks and opportunities. By implementing thoughtful insurance strategies, they can protect their ventures, ensure continuity, and focus on growth. However, as there are complexities in setting up the structure of these protections correctly, for small business owners, it is strongly recommended that you seek guidance from professionals. At Salt Financial Group, our Advisers and Accountants can ensure you, and your business, are covered against life’s unexpected circumstances. Remember that informed decisions today lead to a more secure tomorrow.