If any business is a good candidate for Key Man Insurance, it is a Real Estate Broker. Knowing that the success of the broker’s organization is typically predicated on the success of a small group of people, every real estate broker should consider Key Man insurance to ensure the continuation of the organization in the event of the death of a key person.
Definition: Key Person Insurance is life insurance purchased by the business organization on the life of the key person or persons, with the organization listed as the beneficiary. There is an insurable interest between the organization and the key person because of the loss of revenue that is anticipated as a result of the death of the insured. A key person is defined as a person who is crucial to the operation of the business and whose absence would be detrimental to the continuation of the organization.
Why the Importance for a Real Estate Broker?
The nature of the operation of a real estate brokerage organization makes it the perfect candidate for key man insurance. Most broker operations depend on a handful of key individuals for the majority of the revenue that supports the operation. These individuals could be officers of the company, partners in a partnership, or team members who have proven to be financially valuable for the company to continue operations.
It’s not only about commissions. Many key individuals are considered irreplaceable because of their client list, industry experience, or knowledge of the real estate closing processes. Many team members are considered invaluable because of their marketing results or technology skills.
The broker only needs run reports that indicate closing percentages, listing activity, commissions paid, and marketing successes to quickly understand who the rainmakers are in the organization.
How it Works
The broker principal designates who in the organization is considered a key person and purchases a life insurance on that person, pays the periodic premiums, and is the beneficiary of the policy. If the key man dies unexpectedly, the brokerage (company) would receive the death benefit from the insurance company tax-free.
The real estate broker would then have the necessary to fund the expenses that result from the death of the key person:
- Recruiting costs for a replacement.
- Pay off debts to reduce operation costs while a replacement search is underway.
- Distribute money to investors in the operation.
- Pay severance packages if the decision is to close the office.
- If the key person has survivors with shares of ownership, the company can use the funds to buy out the those survivors’ shares and regain ownership.
Which Type of Insurance Should be Used
The most affordable life insurance product to fund your key man insurance plan is Term Life insurance. Since term insurance provides temporary coverage for up to thirty years and the product has a very low mortality rate, this insurance is much more affordable than permanent insurance, such as Whole Life or Universal Life. Other key benefits that make term insurance a preferable product are:
- Most carriers offer policies for up to thirty years.
- Many carriers offer a “return of premium” rider that allows the insurance carrier to return all premiums paid on the policy to the broker if the key person outlives the policy term. The broker could use some or all of this “lump-sum” returned premium as a retirement gift for the loyal key person or as a signing bonus for the retiree’s replacement. The money belongs to the broker and can be used in any way they choose.
- Some carriers offer an “accelerated death benefit” rider. This rider allows the insured to receive a large percentage of the death benefit if diagnosed with a terminal illness.
How Much Key Man Insurance Should I Buy?
The amount of insurance you purchase for a key person should be predicated on the risk involved. The risk is determined by calculating the costs that are likely to be incurred by the loss of the key person. These costs will be related to loss of revenue, loss of clients, loss of pending sales, and many other ways the organization would be affected by an untimely death of the key person.
Most experienced insurance professionals have substantial key person knowledge for the real estate industry and can help the broker principal establish an amount sufficient to cover the anticipated costs of losing a key person in the organization.
Is the Death Benefit Taxable?
Unless the required Notice and Consent requirements of Section 101(j) are met, the death benefit from the insurance policy will be considered income and therefore taxable to the broker (beneficiary) and owner of the policy. The Notice and Consent requirements must be met before the insurance policy for each Key Person is issued by the insurance company. According to IRC 101 § (j) Treatment of certain employer-owned life insurance contracts, the following requirements must be met:
- the employee is notified in writing that the applicable policyholder intends to insure the employee’s life and the maximum face amount for which the employee could be insured at the time the contract was issued,
- the employee provides written consent to being insured under the contract and that such coverage may continue after the insured terminates employment, and
- the employee is informed in writing that an applicable policyholder will be a beneficiary of any proceeds payable upon the death of the employee.
In addition to the notice and consent requirements, form 8925 is required to be included with the employer’s annual income tax return which includes the following information:
- The number of employees at the end of the year.
- The number of employees who are insured at the end of the year under employer-owned life insurance contracts.
- The total amount of life insurance in force at the end of the year under these contracts.
- The name, address, and taxpayer identification number of the employer and the type of business in which the employer is engaged.
- Whether the employer has a valid consent for each insured employee, and if not, the number of insured employees for whom a consent was not obtained.