The protection industry has frequently marketed relevant life cover under the heading of business protection, for convenience as much as anything else.
Though it’s true that employers set them up and pay the premiums, the one entity that remains ineligible to receive any benefits from the policy is the employer. Thus, relevant life policies are clearly not suitable as a form of key person cover.
Some advisers have told me they use relevant life for the purpose of shareholder protection. In some (very limited) circumstances, this could work. However there is no guarantee this method will deliver for shareholders. Let’s not forget: relevant life policies are more akin to one-man death in service schemes, without the pension tax implications but with the added bonus that they are portable.
The trust that wraps around them is a discretionary trust, which is principally designed for the protection of the life assured’s financial dependents.
The trust wording typically groups potential beneficiaries into ‘classes’ rather than by name. This enables the trustees to properly exercise their discretionary powers when distributing the policy proceeds in the event of a death or terminal illness claim.
The normal classes of potential beneficiaries are typically listed as follows:
- (a) The member
- (b) Any spouse, widow or widower of the member
- (c)The children and remoter issue of the member whenever born
- (d) Every spouse, former spouse, widow or widower of any such child or remoter issue
- (e) The brothers and sisters of the member and their issue
- (f) Any one or more persons who are members of the family or household of the member and who are beneficially entitled under the will (or any codicil thereto) of the member or who would be entitled to an interest in the member’s estate if the member had died intestate
- (g) Any individual who is part of the member’s family or household and whose name is given in writing to the trustees by the member as a potential beneficiary
- (h) Any charity
- (i) (Please insert the names or class of any other individuals who should be included as Potential Beneficiaries but are not covered under (a) to (h))
So, unless all of the surviving shareholders in the business all fall into these categories, then the settlor (i.e. the employer) would need to list the other shareholders in (i) above - which is an empty box on the trust form - and create a new class of beneficiary (they would also need to do this if they have an unmarried partner and no will in place).
Even if they do create another class of beneficiary, it still doesn’t guarantee that the trustees won’t exercise their discretion in favour of dependent family members first; leaving the business owners with nothing.
So even if you are dealing with a close-knit family business, this is not an effective method of providing the necessary cash to fund the share purchases that may be required by any double option agreement.
In summary then: when should a relevant life policy be used as a business protection tool? In short, it shouldn’t. It won’t ensure survival of the business, and it can’t be guaranteed to deliver the necessary funds to the right people for shareholder protection.
Paul McDowell is a business account manager at Zurich
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