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Key Person Insurance Policies Revisited

Sonja FrankAmendments to the tax legislation on key person insurance policies require employers to take action in respect of certain policies before 31 August 2012.

The tax amendments, which came into effect on 1 March 2012, pertain to the so-called “genuine key person” and “false key person” plans as explained by SARS in its Explanatory Memorandum. According to SARS, employers entering into genuine key-person plans desire a tax-free payout, while employers with false key person plans seek to obtain an upfront deduction without a corresponding fringe benefit in respect of the premiums paid for the employee.

Employers who seek an upfront deduction for key person policies must now “opt into the regime” by expressing a choice in the policy agreement or by means of an addendum thereto. For policies that existed prior to 1 March 2012, this must be done before 31 August 2012. Policies entered into after 1 March 2012 should provide for this choice in the policy documents.

It is expected that the practice of taking out key person policies by employers for their own benefit will continue. However, employers often take out key person policies with the intention of applying the proceeds for the benefit of the employee’s dependants upon his death. The policy is then structured so that the employee is the direct beneficiary. Alternatively, there may be a separate agreement that determines that the employer will have to pay over the proceeds to the employee’s dependants.

The following tax rules apply:

Proceeds received by employer

  • All amounts directly or indirectly received or accrued from an insurance company in terms of an employer-owned insurance policy must be included in the gross income of the employer.
  • An exemption may be claimed by the employer when the policy proceeds are from a genuine key person plan and no upfront deduction has been claimed.
  • A deduction may be claimed by the employer when the employer is obliged to pay over the proceeds to the employee upon his death. Pay-as-you-earn must then be deducted from the proceeds payout.

Proceeds received by the employee

  • All amounts directly or indirectly received or accrued from an insurance company in terms of an employer-owned insurance policy must be included in the gross income of the employee, regardless of whether the employee’s estate or his dependants are the beneficiaries.
  • The employee may claim an exemption in cases where:

the premiums have been funded by the employer with post-tax contributions; and

the premiums have been taxed in the hands of the employee as a fringe benefit.

  • Carefully consider the estate duty implications of a policy paid out for the benefit of an employee’s dependants. It may form part of the assets of the deceased for estate duty purposes if it does not pass the test of key person insurance as defined in the Estate Duty Act.

For more information call Sonja Frank of Exceed Trust at 021 882 8140 / sonja@exceed.co.za.