Business life policies, such as a keyman policy or a contingent liability policy, are essential to ensure the long-term survival of your business should something happen to you.
Sarah Love of Private Client Trust explains the difference between the two types of policies:
“A keyman policy is intended to help a business survive the death or disablement of the founder/manager, or a person key to the ongoing operations of that business. Individual talents are becoming critical to the success of many companies and every business has very valuable employees who contribute significantly to the running and growth of the company. It makes sense to insure against the unfortunate event of your own untimely demise, or the death of a key staff member.
“Contingent liability insurance refers to a policy taken out by a business on the life of an employee, director or business owner who stands surety for the debts of the business. The amount of cover taken out should be equal to the loan amount, adjusted for tax. In the event that the person who stands surety dies before the loan has been settled, contingent liability insurance ensures that the outstanding loan amount is repaid in full, which means that the estate of the person who stands surety is absolved from further liability and the business is not placed under undue financial strain.”
Tax treatments – what you need to know
However – one must bear in mind how they are treated differently when it comes to tax. According to Jeremy Burman of Private Client Financial, there is a large difference in the tax treatment of business life policies.
Burman explains that section 11(w)(ii) of the Income Tax, Act 58 of 1962 allows a company to claim a tax deduction on the insurance premiums paid on the life of an employee, so long as the policy is:
- Owned by the employer company;
- The company is insuring against financial loss that would be caused by the death, disability or severe illness of an employee;
- The policy is a risk policy without a cash or surrender value;
- The company makes an irreversible election to have the premiums deducted for income tax purposes.
“In the event that such a policy pays out, it is necessary to consider whether the proceeds will be subject to income tax or capital gains tax. If a choice was made in terms of section 11(w)(ii) to deduct the premiums for income tax purposes, then the proceeds received are regarded as falling into the definition of gross income and will be subject to income tax in the hands of the company.
“Where the premiums were not deductible or the election in terms of section 11(w)(ii) was not made, the proceeds received will be regarded as being of a capital nature and so not subject to income tax. These capital proceeds are also exempted from capital gains tax under paragraph 55 of the Eighth Schedule of the Act, so long as there was no cash or surrender value attached to the policy, and the company is the original owner of the policy,” says Burman.
And then there is Estate Duty to consider
In terms of the Estate Duty act life policies attract Estate Duty as a deemed property. Love explains that there are a few exceptions including one for a keyman policy, if certain requirements are met:
- that the policy was not effected by, or at the instance of, the deceased; and
- no premium was paid or borne by the deceased; and
- no amount has been, or will be, paid to or utilized for the benefit of any relative of the deceased or any company which was at any time a family company.
“As such, a properly set up keyman policy will not attract estate duty. However a contingent liability policy will attract estate duty and the amount taken out would need to be adjusted for this,” says Love.
In conclusion, business life policies are not as straight forward at they seem and one should always consult with a wealth manager or tax expert to ensure you fully understand what you are applying for.