Executive Benefits and Key Person Coverage: When You Need Them

Two ideas that often get lumped together

Executive benefits and key person coverage sound similar, but they solve different problems. Executive benefits are extra compensation and protection for a small group of leaders, offered on top of your regular group plans. Their main purpose is to attract, reward and keep those leaders.

Key person coverage is protection for the company itself. The business buys insurance on someone whose skills, relationships or knowledge it depends on, and the business is the one that benefits if something happens to that person. The purpose is to give the company financial breathing room during a disruption.

A company can use one, both or neither. The right answer depends on how much of your results rest on a few people.

What these arrangements can look like

There is no single product here. Executive benefits are usually built from a menu, and key person coverage comes in a few forms. Here are the most common pieces you will hear about.

• Supplemental life or disability coverage for leaders, added on top of group limits that may not stretch far enough for higher earners.
• Nonqualified deferred compensation, a written agreement to pay a leader later, often tied to staying with the company for a set period.
• Supplemental retirement arrangements that go beyond what a standard retirement plan allows for highly paid employees.
• Key person life insurance, owned by the company, on an owner or critical employee.
• Key person disability coverage, designed to help the business if a critical person cannot work for an extended time.
• Life insurance used to fund a buy-sell agreement, which sets out how ownership changes hands if an owner dies or leaves.

Why your group plans may not be enough

Group life and disability are built for broad participation. Benefit amounts are often capped, and the cap can leave a gap for someone whose income and responsibilities are much larger than the average employee's. That gap is where supplemental coverage tends to come up.

Group retirement plans also have limits and testing rules. When owners and highly paid employees would like to set aside more than the plan allows, or the plan's rules restrict what they can do, employers sometimes look at supplemental arrangements.

None of this replaces your core benefits. Your general workforce still comes first, because broad benefits are what most employees notice and use every day.

Signs your company may be ready to look

Most growing companies do not need any of this on day one. The questions start to matter when the business has become something worth protecting and a few people carry a large share of it. Ask yourself the following.

• Would losing one person stall sales, operations, licensing or a major customer relationship?
• Does a lender, investor or bonding company rely on a specific leader being in place?
• Do you have co-owners who have never put in writing what happens if one of them dies or becomes disabled?
• Are your top people being recruited by competitors, and is your offer mostly the same as everyone else's?
• Is a founder planning to step back in the next several years, with no successor ready?
• Does one person hold knowledge that exists nowhere else, such as pricing logic, customer history or compliance know-how?

Rules to understand before you buy anything

These arrangements carry legal and tax requirements, and mistakes can be costly. Describing the rules in general terms is as far as an article can go, so confirm the details with a licensed advisor, an attorney and your tax professional before you commit.

For company-owned life insurance, federal tax rules generally require that the employee be notified and give written consent, along with other conditions, for the death benefit to keep its favorable tax treatment. Skipping the paperwork can change the tax result. Premium deductibility and the tax treatment of benefits also depend on how the policy is structured.

Deferred compensation is governed by strict timing rules. A poorly written agreement can trigger tax problems for the person it was meant to reward. These promises are also usually unfunded, which means the employee is generally relying on the company's ability to pay.

Executive health and fringe perks can raise nondiscrimination questions, especially if you favor highly paid people in a way that group plan rules do not allow. Underwriting matters too. Insurers look at age, health and coverage amounts, so approval and terms are not automatic.

Practical next steps this month

You do not need to buy anything to make progress. Start by getting clear on what you would actually be protecting, then work from there.

If you want an outside view, a benefits review with an advisor is one option for seeing where your group coverage stops and where other tools might fit. Bring your accountant and attorney into any decision that touches ownership or taxes.

• List the five or so people whose absence would hurt most, and write down exactly what would break without each one.
• Check your current group life and disability limits to see how they apply to your highest earners.
• Find out whether your ownership group has a signed buy-sell agreement and whether anyone has reviewed it recently.
• Ask your lender or bonding contacts whether any agreements name specific people.
• Document critical knowledge, so the business is less dependent on one person's memory.
• Schedule a conversation with your tax professional and attorney before any policy or agreement is signed.

This article is general education for employers, not legal, tax or plan advice. Benefit rules and options depend on your group size, location and plan, so talk with a licensed advisor before making changes. Sixth Man Employer & Insurance Services, CA Insurance License #0I01929.