Key Man Insurance: Safeguarding Your Business From the Unexpected

The Business Is the Owner and Beneficiary

The company purchases the policy, pays the premiums, and receives the death benefit if the insured key person dies or becomes disabled (if disability coverage is included).

Employee Consent Required

The insured employee must provide written consent for the company to take out a policy on their life.

Benefits Upon Death or Disability

The death benefit provides a financial safety net for the business to navigate the challenging period following the key person's departure.

Funds for Various Needs

The payout can be used for expenses such as recruiting and training a replacement, covering lost income, paying off business loans, or even winding down the business if necessary. 

High Reliance on Key Personnel

If the business's operations or revenue are heavily dependent on a specific individual's skills or expertise.

Securing Loans or Investments

Lenders or investors may require key man insurance as a form of collateral to protect their investment.

Business Continuity Planning

To ensure the business can continue operating smoothly in the event of a key person's sudden absence.

Buy-Sell Agreements

To fund the buyout of a deceased partner's shares, ensuring a smooth transition of ownership.

Sole Proprietorships

To provide a financial payout to heirs if the business needs to be closed after the owner's death. 

Term Life Insurance

Provides coverage for a specific period (e.g., 10, 20, or 30 years) and pays out a death benefit if the key person dies within that term. This is generally the less expensive option.

Permanent Life Insurance

Offers lifelong coverage and builds cash value over time, which the business can borrow against or potentially use as a retirement benefit for the employee. This type of policy has higher premiums than term life insurance.

Key Person Disability Insurance

Provides a payout if the key person becomes disabled and is unable to work.

Critical Illness Insurance

Provides a benefit payment if the key person is diagnosed with a covered critical illness. 

Premiums Are Generally Not Tax-Deductible

The premiums paid for key man insurance are typically not considered a deductible business expense.

Death Benefits Are Usually Tax-Free

The death benefit received by the business upon the key person's death is generally not subject to income tax. However, C corporations may need to include the death benefit in the calculation of their alternative minimum tax (AMT) due.

Specific IRS Guidelines

It's important to be aware of IRS regulations concerning employer-owned life insurance policies, particularly those related to notice and consent requirements.