Key Man Insurance

 

As a company, we put a lot of our time and effort is not only growing talent but also making a substantial investment in each of our employees. In such a scenario, it is only good sense to ensure the position of an employee that is invaluable to the unhindered running of the company.

And this is where keyman insurance comes into play. Keyman insurance is defined as an insurance policy where the proposer, as well as the premium payer, is the employer, the life to be insured is that of the employee, and the benefit, in case of a claim, goes to the employer. The `keyman’ or ‘key person’ would be any person employed by a company having a special skill set or substantial responsibilities and who contributes significantly to the profits of that organization.

The death of the employee can incur two types of losses to the company:

(a) Loss arising from profit reduction for the company

(b) Costs for the company in replacing the keyman

In case the company has keyman insurance, on the death of the employee, the sum assured is paid to the company. This sum assured is generally quite large and sufficient to not only tide over any business downturn but also hire a new senior executive. If the insured person survives the term of the insurance then no money is paid to the company.

Tax implications of Keyman insurance policy

There are different types of tax implications of a Keyman insurance policy on the premiums paid as well as on the benefits received. Let’s understand these implications for the employer as well as for the employee in details:

Tax implications for the employer:

  1. On the premiums paid
    The premium paid for buying a Keyman insurance policy is considered to be a business expense. This expense is allowed to be deducted from the taxable profits of the company under Section 37 (1) of the Income Tax Act. This deduction, therefore, lowers the taxable profits of the company and reduces its tax liability.
  2. on the death benefit received
    The death benefit received by the company in case of death of the insured employee is fully taxable. The benefit is considered to be an income in the hands of the company and it is taxed as per the company’s tax slab rates. The exemption benefit under Section 10 (10D) is not available under Keyman insurance.

Tax implications for the employee:

  1. On the premiums paid
    The premium paid by the employer is not considered to be a taxable perquisite in the hands of the employee as per Section 17 (2) of the Act. Thus, the employee incurs no tax liability on the premiums paid.
  2. On the death benefit received

    Since the death benefit is not received by the employee or his dependents, there is no tax liability. However, if the Keyman insurance policy is assigned to the employee when he quits the employer, the employee becomes the owner of the policy. The employee, then, nominates an individual to receive the policy benefits in case of his/her death. In this case, the death benefit is paid to the employee’s nominee. This death benefit would be taxable. No tax benefit would be allowed under Section 10 (10D).

Benefits of Keyman insurance policy

A Keyman insurance policy is considered to be very beneficial for the business because of the following reasons –

  1. The policy helps businesses face the financial loss incurred in case their key employees die prematurely
  2. The policy gives a boost to the morale of key employees as their importance is outlined through the Keyman insurance cover on their lives
  3. The price of the company’s stocks do not fluctuate wildly when the company has a back-up plan in the form of Keyman insurance even in case of death of its key employee
  4. The premium paid for a Keyman insurance policy is considered a business expense. Businesses can claim tax benefits on such expenses
  5. If the business has availed loans on the key employee’s guarantee, the death of the employee would result in substantial liability in the hands of the business. The policy proceeds of a Keyman insurance policy can help the business meet such liabilities and avoid a financial crisis
  6. If the company is being acquired by another company, the valuation of the company would be higher if it has a Keyman insurance policy covering the risk of premature death of its key employees

Drawbacks of Keyman insurance

Though a Keyman insurance policy is very beneficial, there are some drawbacks of the policy too. These drawbacks include the following:

  1. Since the death benefit is taxable, the company has to part with a considerable amount of benefit towards tax. This reduces the effective benefit received by the company for the loss of its employee
  2. Only term insurance plans are available under Keyman insurance which might not be suitable for every business

Things to remember about Keyman insurance

Here are some important things which you should remember about Keyman insurance policy –

  1. The company cannot choose riders under the plan
  2. The nominee of the policy would be the employer who is also the policyholder
  3. Loans cannot be taken under Keyman insurance plans
  4. The employee is neither required to pay the policy premiums nor does he/she receive any death benefit

Taxation aspects of Keyman insurance:

Prior to change in rules, companies could buy cash value life insurance policies as keyman insurance. In many cases, after buying such a policy the company assigned it to the Keyman during the tenure of the policy. In return the Keyman would generally pay the surrender value of the policy (which was very little compared to the premiums paid and also the maturity value of the policy) to the company. The Keyman would keep the policy and then on maturity of the policy the Keyman would get maturity 

In the hands of the company :

The premium paid by the company buying the Keyman insurance policy is an allowable business expenditure for the company under section 37(1) of the Income-Tax Act.

In case there is a claim (on death of the insured), the claim proceeds are taxable as business income in the hands of the company. The Keyman insurance policy death benefits are not tax-free under section 10 (10D) of the Income Tax Ac

In the hands of Keyman :

The premium paid by the company is not taken as a perquisite in the hands of the Keyman under section 17(2) of the Income Tax as the policy is for the benefit of the company and not the Keyman. The Keyman is thus not required to pay any tax on the premium paid by the company on a policy on his life. There is no maturity or surrender benefit either to the company or to the Keyman as now only term policies can