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What is keyman insurance and why do you need it?

by , 26 August 2013
Most businesses, especially small, family-owned and operated or fledgling businesses, depend heavily on the skills of one or more key people. If you're one of these businesses, here's some constructive advice on how to safeguard your business: Take out keyman insurance! It'll protect you from the loss or disability of one of your keymen in a practical and tax-effective way...

According to the Practical Tax Loose Leaf Service, most businesses depend heavily on one or more key people. They're the essential staff members who have the crucial skills to ensure the smooth functioning and continued success of the business.

These people are as vital to a business as its physical and capital assets.

And your business would suffer severely if one of these important key people were to become disabled, or even worse die.

Luckily there're a tax-effective way to protect yourself and your business against these a potentially devastating loss: Keyman insurance.

What is keyman insurance?

The Practical Tax Loose Leaf Service defines keyman insurance as a life policy on the life of the keyman or woman in your business.

It helps provide cash on the death or disability of the keyman, which you can use to:

  • Keep the business running;
  • Cover the losses during the time taken to replace the key individual;
  • Cover the costs of training, recruiting and vesting the replacement; and
  • Ensure continuance of credit lines.

It's quite clear that the benefits of keyman insurance are considerable.

But like all aspects of your business, there's an optimal way to structure your policies so you get the maximum financial benefit from your payouts

Let's take a closer look at how it all works.

How does a keyman structure work?

Keyman assurance is simply a life policy, purchased (usually, but not always) by a company or on the life of an owner, director or employee (the keyman), whose services are key to the success of the company.

The policy is owned by the company and the premiums are paid for by the company. When the keyman dies, or becomes disabled, the proceeds are paid to the company for the benefit of the company. It'll be used to compensate the company employer in the various ways mentioned above.

The tax effects of the structure of keyman insurance

According to the Practical Tax Loose Leaf Service,the Income Tax Act stipulates when there will be a deduction of a premium paid for a policy on the life of an employee or director.

For a policy to be deductible, it must conform to the Act and is referred to as a 'conforming policy'.

The Practical Tax Loose Leaf Service explains that the issue which always arises is which option is better for you.

Should you take out the policy as a conforming one, with premiums that are tax deductible and proceeds taxed, or should you structure it as a non-conforming deal?

The maths points to the non-conforming route, says the Practical Tax Loose Leaf Service.

Confused by which keyman insurance option is best? Let's take a closer look at how it would all work in practice

Let's say you have cover of R10 million and a premium of R3 000 per month. If the policy is made conforming, your company will get a tax deduction of R3 000 per month.

That means your company will get an annual deduction of R36 000 per annum, but on payout of the policy your company will have to pay tax on the full payout of R10 million.

This structure won't benefit you as premiums will have to be deducted for around 80 years to break even!

This means that in general, the non-conforming route is the way to go. It's better to forego the small upfront deduction to ensure the big lump sum at payout time is tax free.

Well there you have it. if your company ticks the boxes, consider keyman insurance to safeguard your business.

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