Key person insurance is a type of insurance purchased on the life of a key company executive.
The purpose of key person insurance is to provide a financial payout to the company if the executive dies or becomes too disabled to work so the company can keep operating until it finds a replacement for that person. Key person insurance is otherwise known as key woman insurance, key man insurance, or business life insurance.
What is the Purpose of Key Person Insurance?
Some high-ranking executives in a company would be difficult to replace if they were to pass away or become unable to work. The company’s business strategy and revenue could be significantly affected, causing large financial losses.
To mitigate this risk, a business can take out key person insurance on the lives of its most important executives. The company is the beneficiary of this type of policy, and the payout can help compensate for any financial hardship to the business caused by an executive’s death.
How Does Key Person Insurance Work?
A key person insurance policy is similar to other types of life insurance. The primary difference is that a company, rather than an individual, purchases and is the beneficiary of the policy.
Companies buy key person insurance to help them pay business expenses if an important employee dies or can’t continue working. These can include debts, investor distributions, salaries, severance pay, and other things.
Key person insurance can prevent a company from immediately going bankrupt if its owner or another high-ranking executive dies and the business can no longer operate.
A small business usually designates the owner as the key person, as well as perhaps one or two other people. Consider key person insurance for anyone in the company whose death would significantly hurt the bottom line.
What Is Covered By Key Person Insurance?
Key person insurance covers losses incurred if a key person dies or can’t work but is still alive. These can include:
- Canceled contracts, reduced sales, or other lost income pertaining to projects that involved the key person
- Interests of the remaining partners or shareholders, who can use the insurance payout to purchase the deceased person’s interest
- Protection for guarantors of business loans
How to Get Key Person Insurance
First, decide if your company needs key person insurance. If there’s someone whose absence would prevent the company from operating – often the owner – it’s advisable to purchase a policy.
To purchase key person insurance, ask for quotes from different companies for varying benefit amounts. Policies typically are sold in increments ranging from $100,000 to $1 million.
How Much Key Person Insurance Should I Buy?
To decide how much key person insurance to buy, determine how the absence of the key person would affect the company financially. For example, it’s a good idea to buy a policy large enough to at least cover the business income that the key person produces and the cost of replacing them.
Key Person Insurance Frequently Asked Questions
What is the purpose of key person insurance?
The purpose of key person insurance is to provide financial compensation to a company if a key employee, such as the owner, passes away or can’t work due to an injury or illness. Key person insurance covers things like lost business income stemming from the person’s absence and the interests of the remaining partners or shareholders.
Who are the owner, insured, and beneficiary of a key person life insurance policy?
The business itself typically is the sole owner and beneficiary of a key person life insurance policy. The insured is the person whose death would cause the policy to payout.
Is key person insurance a business expense?
The premiums paid on a key person life insurance policy aren’t tax-deductible as a business expense if the company is the sole owner and beneficiary of the policy. However, benefits from the policy usually aren’t taxed.