Topic 4 Keyperson Insurance

Question 1

Financial difficulties the death of a keyperson who’s an EMPLOYEE may cause

Answer 1

1. A replacement needs to be found for the employee, which could take months and cause considerable financial expenses
2. The new person may need to be trained/upskilled
3. Sales/production may fall or come to a standstill, which will reduce profit until the replacement is up to speed.

Question 2

Financial difficulties the death of a keyperson who’s OWNER may cause

Answer 2

1. Suppliers and banks could insist on stricter credit terms as original agreement might be based on a trust relationship
2. The owner probably understood the market well and knew the right people, so these people could be lost or become strained upon the death of the owner

Question 3

Process of the keyperson insurance

Answer 3

1. Realize or identify that there is a keyperson whose life is needed to be insured
2. Determine the replacement value of the keyperson

Question 4

How to determine the value of a keyperson

Answer 4

1. Arbitrary multiple of annual salary
2. Loss in profits
3. Detailed specification of costs

Question 5

Arbitrary multiple of annual salary

Answer 5

When a company specifies that they need an amount of X times the keyperson’s annual salary

*Annual salary × X
Do examples on pg 113 - 114

Question 6

Loss in profits

Answer 6

Determining the percentage of profits that can be ascribed to the keyperson and to multiply this with the period of the time it would take the new person to become fully operational

[Loss in profits (%) × Profit] × Time to replace (months or years)

Do examples on pg 114 - 116

Question 7

Detailed specification of costs

Answer 7

Specifying the costs that will be incurred in replacing the person.

*Direct costs + indirect costs
Do examples on pg 117 - 119

Question 8

Direct costs

Answer 8

costs of a recruitment agency
advertising costs
training costs
transfer costs
Other costs (temporary replacement, time spent looking for suitable candidate)

Question 9

Indirect costs

Answer 9

Use equation for loss of profit to calculate

E.g. work hours lost whilst training new employee

Question 10

Basic principle of why a keyperson policy is taken out

Answer 10

To protect the employer against any financial loss in the event of a key employee’s death/disablement.

It is owned and paid by the EMPLOYER as the EMPLOYER will benefit from it.

Question 11

Tax implications in respect of the premiums

Answer 11

S11(w) allows a deduction for expenditure incurred by an employer in respect of premiums payable under a policy owned by the employer

Focus o S11(w)(ii)

Question 12

Requirements for premiums to be tax deductible (all must be met)

Answer 12

1. Employer must be insured against any loss by reason of death/disablement/illness of an employee
2. The policy is a RISK policy with no cash/surrender value
3. Policy is not owned by a person other than the employer at the time of payment of premium unless ceded as security
4. If it was taken out on/after 1 Mar 2012 OR before 1 Mar 2012

Question 13

If it was taken out on/after 1 Mar 2012 OR before 1 Mar 2012

Answer 13

1. A statement in the policy must specifically state section 11(w)(ii) to indicate premiums are deductible
2. If taken out BEFORE 1 Mar 2012, an addendum had to be added to the policy before 31/08/2012, which should also have a statement that indicates that section 11(w)(ii) applies

Question 14

Tax implications in respect of the proceeds

Answer 14

Inclusion: Paragraph (m) of section 1 of the Income Tax Act

Exemption: Section 10(1)(gH) of the Income Tax Act

Question 15

Paragraph (m) of section 1

Answer 15

The proceeds of a risk policy that is owned by an employer must be included in the gross income of the employer

No requirements for premiums being deductible because proceeds must be included in the gross income of the employer regardless

Reduced by loan previously made by employer so as to not be taxed twice

Question 16

Section 10(1)(gH)

Answer 16

Provides for an exemption for an employer

Exemption will apply where the premiums in respect of the keyperson policy were not deductible because the statement/addendum was not added

Question 17

CGT implications of keyperson policy

Answer 17

Pure risk policies will always be exempt from CGT, regardless of whom the policy pays

Question 18

Estate Duty implications of the keyperson policy

Answer 18

Any amount due and recoverable on any insurance policy on the life of the deceased is deemed to be property in the estate

Question 19

Requirements for estate duty exemption
Section 3(3)(a)(ii)

Answer 19

1. That the policy was not taken out by or at the instance of the deceased
2. That no premium on the policy was paid or borne by the deceased
3. That no amount has been or will be paid into the estate of the deceased
4. That no amount has been paid or will be utilized for the benefit of any:
   (a) relative of the deceased
   (b) person who was wholly or partly dependent for his maintenance upon the deceased; or
   (c) company that was at any time a family company in relation to the deceased

Question 20

Family company under estate duty act

Answer 20

Any company (not listed) that, at any relevant time, was controlled or capable of being controlled directly or indirectly, in any manner whatsoever, by the deceased or by the deceased and one or more of these relatives

Question 21

Relative

Answer 21

Includes the spouse of the person or anybody related to them or their spouse within the third degree of consanguinity or any spouse of such person

Question 22

Degrees of consanguinity

Answer 22

Each generation counts one degree

1st: father, mother, child
2nd: grandmother, grandfather, grandchild

Question 23

Within the 3rd degree of consanguinity

Answer 23

Spouse and anyone related to them within the 3rd degree (1st)
Children (1st)
Parents (1st)
Brothers and sisters (2nd)
Grandchildren (2nd)
Grandparents (2nd)
Great-grandchildren (3rd)
Great-grandparents (3rd)
Nephews and nieces (not cousins as they are the 4th degree) (3rd)
Uncle and aunts (3rd)
The spouse of anyone on the list is also a relative

Question 24

Premiums paid + 6% compound interest

Answer 24

If the policy doesn’t meet all requirements, the company will have to pay estate duty on the proceeds of the policy, and the amount of life cover has to be increased.

Amount included for estate duty purposes is PROCEEDS - PREMIUMS PAID + 6% COMPOUND INTEREST

Only if premiums are paid by 3rd party

Owner is entitled to proceeds and has paid the premiums

Question 25

Adjusting the value to make provision for income tax

Answer 25

If premiums are deductible:
1. Exemption in section 10(1)(gH) will not apply
2. Therefore, an employee will pay income tax on the proceeds on its applicable income tax rate. (At a flat rate)

Question 26

Adjusting the value to make provision for income tax formula

Answer 26

Cover required ÷ (1 - company tax rate*)

*28% or 27%

Question 27

Adjusting the value to make provision for estate duty

Answer 27

If requirements are not met:
1. Proceeds of the policy will be included as DEEMEND PROPERTY in the estate of deceased keyperson

2. Therefore, the company will be liable for payment of the estate duty at the estate duty rate

Question 28

Adjusting the value to make provision for estate duty formula

Answer 28

Cover required ÷ (1 - Estate duty rate*)

*20% on the first R30 million and 25% the remaining amount

Question 29

Adjusting the value to make provision for estate duty AND income tax STEPS

Answer 29

1. Cover required = Initial cover required ÷ (1 - income tax rate)
2. Answer in step 1 × (Initial amount adjusted to make provision for income tax) ÷ (1 - estate duty rate)