Key Person Insurance: Could your business survive losing one if its key people?
As much as you try to share skills, knowledge and information in your company, you probably have some people who are key to your business’ success.
It might be a Director or the CEO, whose vision made it a success in the first place. It might be your star salesperson, or someone in your IT area who knows the system backwards. It could even be someone who doesn’t create any revenue but does a fantastic job of boosting your company’s reputation or perhaps running your admin and back office systems.
Now, what would happen if you suddenly lost one of those key people?
And if you think it would never happen because they love your business so much, think again. Sure they may not resign. But they might decide to start a family and want to leave the workforce. Or what if they suffered a major illness or injury, or even passed away?
In addition to the obvious issue of lost productivity and their contribution to the business, you also have to spend time (and money) to recruit and train a replacement. And losing such a key person in your company could even affect your reputation and credit standing.
Could your business survive until you find someone who can fill their shoes?
Key Person Insurance can help you get back on your feet
Key Person Insurance can give you the financial support you need while you’re getting back on your feet. It can offset both your costs (e.g. hiring temporary help or recruiting and training a replacement) and your losses (e.g. not being able to do as much business until they finish their training).
It can also help with:
- business succession planning
- protecting your company’s equity value
- agreed funding to purchase the equity
- continuity of equity value for the surviving spouse
- funding re-payments of any capital loans or personal guarantees
- meeting requirements for bank business loans
- salary packaging benefits (depending on the person’s taxation affairs).
And you can take out a policy (which is usually tax-deductible) on anyone you feel is a key person in your company.
How much should I insure them for?
You can set the policy amount to be anything from $500,000 to $10 million. Of course, the amount you specify will depend on the size of your company and the person you’re insuring.
The amount can be calculated in a few ways, including:
- the ‘replacement cost method’, which is based on the cost is to replace the key person
- the ‘contributions to earnings method’, which is based on the percentage of their earnings towards your company’s revenue
- the ‘multiples of income method’, where their current salary is multiplied to determine their value.
Protecting your partners (and their partners) with a Buy/Sell agreement
What if the key person happens to be your partner in the company? Yes, the Key Person Insurance may well cover the finances involved in buying your partner’s shares from their family. But do you really want to be negotiating a deal at such an emotionally trying time?
Having a Buy/Sell Agreement in place can save everyone from a lot of anguish. It’s a legally binding agreement that determines what will happen to each stakeholder’s shares if they suffer a major illness or injury, or pass away.
It has two parts:
- The Disposal Mechanism (also known as a Business Will), which states what happens if a partner leaves the business due to death or disability. It usually contains a valuation method.
- The Funding Mechanism, which funds the Buy/Sell Agreement. This is where you would find the details of the Key Person Insurance policy taken out for each partner.
How do I arrange Key Person Insurance?
Before you take out Key Person Insurance you should first speak with your business advisor about the overall approach and then get into the details with an insurance broker. You need to make sure you get the cover you need without paying for the cover you don’t need. We can guide you in this area.
After all, it may well be the key to your company’s survival.
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One of the most powerful decisions you can make with your superannuation is whether to run your own self-managed super fund (SMSF) and whether to invest in property through it. Most people know it's possible to use super to buy property. Far fewer know how to do it well. The following seven tips are designed to help you make the right decisions. 1. You Can Borrow Money to Purchase Property in Superannuation. Don't have enough in your SMSF to buy an investment property outright? Since 2008, superannuation held in a self-managed super fund can be used to borrow money for property purchase. This is done through a 'limited recourse loan' using a Bare Trust as the Custodian entity. You can't borrow the total value of the property—typically it's up to 80% for residential properties and 60% for commercial properties, with the required deposit held in the SMSF as security. The SMSF then makes the loan repayments, with rental income received by the fund and property expenses paid by the fund. Importantly, if there is a default on the loan, your other assets in the SMSF are generally protected from standard debt recovery and bankruptcy proceedings. The lender only has recourse to the property itself. Upon completion of the loan repayment, ownership of the property transfers legally to the SMSF. 2. Follow These 8 Steps to Set Up Your SMSF Setting up an SMSF properly can be a complex process. It’s best to set up an SMSF with the assistance of a qualified superannuation advisor, like us! We can assist with both the initial setup and the ongoing management of your fund. There are eight core steps to SMSF set up: Select the appropriate structure and name Sign the trust deed that covers how your SMSF is set up and run (it can have up to four members) Establish a trust for the SMSF by investing assets into the fund Register your SMSF with the ATO Set up a separate bank account for your fund Submit your tax file number (and those of any other trustees) Obtain an electronic service address to receive employer contributions into your fund (if applicable) Roll over funds from your existing superannuation account into your SMSF 3. Keep a Liquidity Buffer If you're buying property through superannuation, make sure you plan to keep a liquidity buffer of cash and/or shares in your fund. Lenders will check for this before lending to you—it should be at least 10% of the value you intend to borrow. But beyond satisfying the bank, it's simply good risk management. Property is an illiquid asset. Having accessible funds in the SMSF means you're not caught short if repairs are needed, the property sits vacant, or an unexpected expense arises. Because superannuation is central to most Australians' retirement security, the government has carefully regulated what can and can't be done with it. They don't want people gambling their retirement away on poor investments or incorrectly using their superannuation fund. 4. Use the Rental Income to Repay Your Loan You cannot live in the property you purchase through your SMSF until after retirement. Most people purchase an investment property and use the rental income generated to repay the loan—which makes excellent financial sense. The key is selecting a property that rents easily and delivers a strong rental return. Your purchasing criteria may look a little different to buying a home you'd live in yourself. For example, proximity to public transport, local amenities, and average rental rates in the area matter more than personal preference. 5. Get It Right and Enjoy Significant Tax Efficiencies One of the most compelling reasons to invest in property through superannuation is the tax efficiency on offer. These benefits can significantly improve the long-term return of a property investment compared to holding it in your own name. Key tax benefits include: No capital gains tax or tax no yearly investment earnings if under super caps. Salary sacrifice advantages if you're sacrificing salary payments into super, loan repayments are effectively tax deductible. Capped tax on investment income—the maximum rate of tax on income after expenses is 15%. Any capital gains on investments held for 12 months or more, is taxed at 10%. Standard investors outside super can pay up to 47%. 6. Follow the Same Due Diligence Rules as Any Property Purchase Buying through superannuation doesn't mean relaxing your standards. If anything, the rules governing SMSFs mean you need to be more rigorous, not less. Property is likely one of the most significant financial decisions of your life. Research, not emotion, should drive your choices. The same rules apply whether you're buying in or out of super: Visit and compare multiple properties Know the values of similar properties in the same area Get all property checks performed by the right professionals Shop around for the right loan structure and lender Don't abandon good investor habits just because the structure is different. 7. Always Get Quality Professional Advice Nothing comes without risk—but the right advice significantly mitigates it. The key is understanding what you're getting yourself into: making informed decisions based on accurate data; keeping a diversified superannuation portfolio that doesn't place all your eggs in one basket; and not underestimating how complex buying property in superannuation can be. Sound Simple? It’s all in the details. If the above tips have made it sound straightforward, know that the detail is where the complexity lives. Getting professional advice from the start helps ensure you make the best possible decisions for your future. When selected according to rigorous property-purchasing criteria, property can be an excellent way to grow your superannuation and increase your chances of building a retirement fund that supports the lifestyle you want. Ready to Explore Property in Your SMSF? Whether you'd like to discuss whether an SMSF is right for you or need help setting one up, reach out to Ascent Accountants . If you want assistance managing the property within your fund, contact the Ascent Property Co team .
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