What is key person insurance?

Many small businesses rely on a few people to keep things running. It might be the owner, a top salesperson or the person who knows how everything works.

If that person died suddenly, the business could struggle. Key person insurance is one way to plan for that.

How key person insurance works

Key person insurance is a life insurance policy owned by a business. The business owns the policy and receives the payout if the insured person dies.

Here's the basic setup:

• The business is the owner of the policy.
• The business pays the premiums.
• The business is the beneficiary.
• The insured person is the key employee or owner.

The business can then use that money where it's needed most. Policies can be term or permanent, and our guide to term vs. whole life explains the difference.

Who counts as a key person

A key person is someone whose loss would hurt the business in a real way. This is often more than just the owner.

Think about people who:

• Bring in a large share of sales or clients.
• Hold special skills or licenses that are hard to replace.
• Have strong relationships with vendors or partners.
• Lead daily operations or manage the team.

A simple test is to ask, "What would happen to us if this person were gone tomorrow?" If the answer is worrying, that person may be a key person.

How the money can be used

The death benefit gives the business cash at a hard time. That can buy time to make good decisions instead of rushed ones.

Businesses may use it to:

• Find and train a replacement.
• Pay business debts.
• Help keep the business running while things settle.
• Help buy out a deceased owner's share from their heirs.

That last use often ties into a buy-sell plan. Learn more in how buy-sell agreements get funded.

Tax and legal points to know

The tax treatment of key person insurance depends on how the policy is set up and owned. For example, IRS guidance says a business generally can't deduct these premiums when it is a beneficiary, but your CPA should confirm what applies to you.

There are also federal rules for employer-owned life insurance. In general, the employee must get written notice and give written consent before the policy is issued, and the business has yearly reporting to do.

Missing these steps can affect how the death benefit is taxed. That's why we work alongside your CPA and attorney to help make sure the paperwork is handled the right way.

Common questions

Who owns a key person insurance policy?

The business owns the policy, pays the premiums and is the beneficiary. The key person is the one whose life is insured.

How much key person insurance does a business need?

There's no single right amount. Businesses often look at the cost to replace the person, any debts and how long recovery might take.

Bottom line

Key person insurance can help a business stay steady if it loses someone important. It won't replace the person, but it can give the company time and money to adjust.

If your business leans on a few people, it may be worth a closer look. You can learn more on our business owner solutions page.

Have questions about your situation? Book a complimentary call with our team.

This article is for general education only and isn't financial, tax or legal advice. Product features vary by carrier and state. Talk with a licensed professional about your situation.