As a CPA practice owner nearing retirement, you’ve likely devoted significant thought to your exit strategy. But what if, just before you’re ready to step away, one of your key team members becomes unable to work due to illness, disability, or even death? While it’s a difficult scenario to contemplate, planning for every possibility is necessary to safeguard the value of your business.
If you’re approaching retirement, now is the time to take stock of all your risks and evaluate the value of Key Person Insurance as a part of your comprehensive retirement strategy. This often-overlooked type of insurance can be essential in protecting not just your practice’s financial stability but also your own retirement goals.
Why Key Person Insurance Is Critical for CPA Practices Near Retirement
Key Person Insurance is designed to protect a business from the financial disruption that can occur when a crucial team member—such as a sales expert, a niche CPA, top talent, or even an IT specialist with unique skills—can no longer perform their duties. This risk becomes especially significant if you’re planning to sell the firm or transition to retirement. The sudden loss of key talent could reduce the value of your business, complicate a sale, or even delay your retirement plans.
Key Person Insurance can help mitigate these risks by providing financial support to maintain operations, cover the costs of finding a qualified replacement, and stabilize the business during the transition.
The Mechanics of Key Person Insurance
Key Person Insurance is straightforward to understand. The business itself takes out an insurance policy on key personnel with their permission. In the event that this individual becomes disabled or passes away, the policy pays out a lump sum to the company, helping to offset financial losses resulting from the absence of this key person, whether through business interruption, training costs, or losses in revenue.
Gauging Adequate Coverage
Determining the right amount of Key Person Insurance coverage can be challenging, as there’s no universal formula that fits every CPA practice. The amount of coverage should ideally reflect the potential financial impact on your firm. Often, the desired coverage amount may exceed what the business is willing to pay in premiums, especially if the firm is in a growth phase or facing other financial constraints. In such cases, starting with a smaller coverage cap that addresses the most critical risks and then adjusting as the business evolves is one potential solution.
When determining how much coverage you need, you first need to figure out how much the loss of a key person could cost your business. For instance, recruitment and replacement costs can add up quickly, especially if you need to hire someone with specialized skills or offer incentives to attract top talent. Additionally, losing a key team member can disrupt operations, leading to productivity dips, missed deadlines, or delayed projects, which can be particularly damaging during busy periods like tax season.
The loss may also impact client relationships. If a key CPA or partner is suddenly unavailable, clients may become concerned about the continuity of service, potentially resulting in lost business or reduced revenue. Moreover, managing the transition itself can take significant time and effort, diverting your focus from other important tasks, such as preparing your practice for sale or retirement.
To arrive at a ballpark figure for coverage, one method is to add the key person’s salary to their direct contribution to the firm’s bottom line and multiply that total by a factor—often five or more. This will give you at least a starting point to start working from.
Below are a few of the most important factors to take into account when determining coverage, along with potential financial impacts:
It may be impossible to factor every aspect accurately enough to determine a precise coverage amount. Therefore, starting with a reasonable amount of coverage and adjusting as your firm grows can help you manage costs while still providing meaningful protection.
Choosing the Right Type of Policy: Term vs. Permanent
When shopping around for Key Person Insurance, you’ll be faced with two main options: term or permanent policies. Term life insurance is more affordable and great for temporary coverage, as it only remains in effect for a certain period, say ten or twenty years. This can be a good choice if you want coverage that aligns with the key person’s expected retirement date or the sale of the business. However, keep in mind that premiums will increase if you renew the policy as the person ages, and there is a risk of them becoming uninsurable due to health changes.
On the other hand, while more expensive, permanent life insurance policies offer additional benefits that can help cover the loss of a key person and more. These policies don’t expire as long as premiums are paid and can build cash value over time. This accumulated cash value can be borrowed against for future expenses, such as funding buy-sell agreements or even supplementing your retirement income. For CPA practice owners close to retirement, permanent insurance may be a wise choice, as it can also serve as a retirement benefit when the key person leaves the business.
In Conclusion
As you approach retirement, the stakes are high, and protecting the value of your CPA practice is more important than ever. While it’s uncomfortable to think about the worst-case scenarios, we also need to be prepared for them. Key Person Insurance can provide a financial safety net to help you navigate the unforeseen and the unpredictable, helping ensure your exit strategy stays on track and your retirement goals remain within reach.
Don’t leave your retirement planning to chance. Incorporate Key Person Insurance into your risk management strategy today. Schedule a consultation to discuss how much coverage you need, the right type of policy for your situation, and how to integrate it into your overall succession plan.
