Preserving $2M Tax-Free Death Benefit of a Key Person Life Insurance Policy

For many businesses, key person life insurance is critical to their risk mitigation strategy. This type of insurance solution helps to reduce the financial hardship that may occur upon the death of an essential employee, such as a top salesperson. This was the case for one Lower Mainland business that set up a life insurance policy on a key person with 50% of the proceeds going to the company and 50% going to the employee’s spouse.

The policy had been in place for over 20 years and the original sales agent of the policy had since died. Our advisors were asked to help when the insurer indicated that the company was no longer a beneficiary of the policy, despite having paid the premiums for the past two decades.

The company’s accountant anticipated a $2M death benefit to be paid to the company, with the remaining $2M paid to the spouse. According to the insurer’s records, the beneficiary of the policy had been changed in 2001, making the insured’s spouse the beneficiary of 100% of the proceeds (the full $4 million).

To further complicate matters, when the policy was sold the spouse was made an irrevocable beneficiary and, prior to death, the key employee and spouse were divorced. Irrevocable designations are often troublesome as it requires the irrevocable beneficiary to approve any future changes to the beneficiary designation. It appeared on the surface that the company would need the spouse’s cooperation to change the beneficiary back to the original.

Could the original purpose of the life insurance be achieved?

Our advisors contacted the insurer and requested copies of all the available paperwork related to the policy. This included documentation from the time the policy was first established and when the beneficiary was changed. In reviewing the documentation, our advisors found that the beneficiary change form, dated 2001, lacked the necessary signatures to execute on the beneficiary change request. On this basis, we contested the insurer’s position that the company was no longer a beneficiary of the policy.

$2 Million Tax-Free Proceeds Achieved!

The process with the insurer took longer than we would have liked, but the outcome was worth the wait for the company. The insurer agreed to pay the company $2M, with the remaining 50% paid to the salesperson’s ex-wife. It remains unclear as to how the beneficiaries were changed in 2001, but through diligent fact checking and voiding the change, the original position was achieved.

We can help protect your capital.

Applying our knowledge of the technical elements of insurance contracts as well as financial and insurance expertise, we were successful in achieving the desired result for our client—tax-free proceeds to the company of $2M.

There were many lessons learned in this situation.

  • It is critical to document the purpose of the insurance, what are we doing and why.
  • Clients need complete records and documentation. Do not rely upon the insurer.
  • Ensure there is a successor in the event your agent passes.
  • Regular review of your insurance policies is critical to protecting capital.
  • Insurance companies are not always correct.
  • Ensure you are receiving impartial and competent advice.

Our clients receive a comprehensive completion package which includes all memorandums, planning documentation, policy summary and illustrations, and policies. These documents ensure that the purpose is achieved and provide the basis for future reviews and planning.

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