Businesses often identify, among the staff they employ, those that make a significant contribution to the success of the business. This may be owing to their special skills, knowledge, education, qualifications or experience. Imagine the impact on the business and productivity if any of these staff members suddenly passed away or became disabled.

Keyperson assurance is there to provide protection against the negative effect that the death or disability of such a key employee would have on the business. The insured amount is a calculation of the loss and additional expenses the business will incur in the event of the death or disability of the key employee, and a life policy with death and disability cover is then taken out on the life of the employee.

If the employee passes away, the policy pays out to the business and these funds may then be utilised to source and up-skill a new employee and absorb the loss in productivity until the new employee has acquired the same level of knowledge and skill.

The policy is taken out by the business on the life of the employee, and the premiums are paid by the business. The proceeds are received and utilised by the business so it is an employer-owned policy and tax implications are applicable.

Keyperson evaluation

There are three methods available to determine the amount of cover required to make provision for the loss of a key employee:

• Seven times the annual salary of the key employee; or
• The number of years it will take a replacement employee to reach the key employee’s level of productivity, multiplied by the loss in business profit resulting from the loss of the key employee; or
• Itemising the replacement cost of the key employee (recruiting, developing a replacement employee and absorbing the loss in business profit)

Income tax

If the requirements of section 11 (w) of the Income Tax Act are met, ‘conforming policy’ premiums will be tax deductible and the proceeds will be included in the gross income of the employer in terms of paragraph (m) of the definition of gross income.

Conditions of section 11 (w)

• The policy must be the property of the employer
• The policy must be on the life of an employee or director
• Only the employer may be entitled to receive any benefit in terms of the policy
• The premium must actually have been paid
• As a general rule, no loans or advances against the policy may be outstanding.

If the policy does conform to the requirements of section 11 (w), the total cover required needs to make provision for the income tax amount which will need to be paid when the business receives the policy proceeds.

If the policy does not meet the requirements, it is a ‘non-conforming’ policy, and the premiums paid are not tax deductible in the hands of the business. The proceeds from this policy will not fall into the gross income of the business under paragraph (m).

Estate duty

The proceeds of a keyperson policy will not be deemed to be the property in the deceased’s estate for estate duty purposes if the requirements of section 3 (3) (a) of the Estate Duty Act are met; which are:

• The policy was not affected by or at the instance of the deceased employee; and
• No premium under the policy was paid or borne by the deceased employee; and
• No amount due or recoverable under the policy has been or will be paid into the estate of the deceased; and
• No amount due or recoverable under the policy has been or will be used for the benefit for any relative or dependant of the deceased or a family company in relation to the deceased.

The challenge is for business owners is to identify key personnel and to establish the value that these key people add to the business, and then insure against this loss by taking out keyperson insurance on that employee’s life.

I recommend that you chat to your NFB Private Wealth Manager if you are considering risk assurance and business assurance cover.