Capital Protection

Capital Protection pays a lump sum benefit to a business, allowing for the repayment of any outstanding business loans or capital for which a deceased or permanently incapacitated business partner or key person was a guarantor.

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Why is it needed?

The resulting death, permanent incapacitation or serious illness to a person may mean that person steps away from the business, removing their obligation as a personal guarantor to any business loans. If a bank suddenly called in a loan, the other business owners may be required to pay it.

How does it Work?

As capital protection is used to pay any outstanding debt or loans, you will essentially need to take out cover to cover these amounts, making it fairly straight forward to work out the amount required.

Things you may want to consider include:

  • Making sure the debt is current and the amount of cover reflects this
  • Making sure the cover reflects the term of the debt as you do not want your cover expiring before the loan expires
  • Understanding the structure of the debt and the guarantees

Policy Structuring

There are a number of ways in which the policy can be structured. While understanding the structure of the debt is always the first step in determining the appropriate structure, other areas which need to be looked at include:

Policy Ownership

Having the business as the policy owner will allow the business to pay the premiums, which may be a possible scenario.

Beneficiary

Allowing your business to be the beneficiary will allow it to receive any benefit from the policy, helping to pay any outstanding loans or debts.

Tax

As Capital Protection does not protect against revenue, premiums are generally not tax deductible. However, any benefits paid out are generally not assessable as regular income. It is also important to note that if the recipient of the benefit is not the original beneficial owner, there may be a capital gains tax liability.

An example of a common capital protection policy structure:

ABC Pty Ltd
Business Loan Director – Guarantors 1
Director – Guarantors 2

In the above example, ABC Pty Ltd has a loan in which the two directors are guarantors and jointly liable for the total debt as well as possibly being separately liable.

Please note, as each business is unique, it is always advisable to consult with your accountant before making any decisions on any type of Key Person Insurance, including the appropriate structure and beneficiary arrangements, and what the tax implications are to the business.

Case Study:

John and Steve are partners in a printing business, with John responsible for the accounting, finance and marketing, while Steve is responsible for operations and inventory. They are joint guarantors on a business loan of $1 million.

They take out $1,000,000 life insurance in their names of with the business named as the beneficiary.

Several years later John has a heart attack and dies, leaving Steve to manage the debts of the business. As Steve was a guarantor on the $1 million business loan, the bank has asked for payment on the outstanding debt.

Fortunately for Steve, the life insurance policy taken out allows the business to receive the benefit so the business can repay the outstanding debt.

Please be advised that this is a general guide only and we are not registered tax agents under the Tax Agent Services Act 2009. If you intend to rely on the advice provided to satisfy liabilities or obligations or claim entitlements that arise, or could arise, under a taxation law, you should request advice from a registered tax agent. Please consult your tax accountant or speak to one of our financial advisers for further information.

Published: March 26, 2015

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