Jun 04, 2025

What Is Key Person Insurance and Do You Need It?

Have you heard of key person insurance? This is a type of life insurance policy that may positively benefit your business’s continuity, though it has both tax and financial implications. Click through to see whether key person insurance is right for your company.

Also known as key man, or key woman, insurance, key person insurance is a type of life insurance policy that a company can purchase. It is available to cover the loss of life or the disability of an individual who is considered a critical component of business operations, such as an owner or a top executive.

Essentially, the company owns the policy and the company also pays the premiums for the policy. Please note that separate riders that offer specific protections may be available as well.

These riders often cover circumstances like disability, catastrophic illnesses, accidental death and dismemberment, the waiver of a premium rider, term conversion riders and buy-sell agreement waivers. 

What is required for the policy to be issued?

In many cases, the key person must be notified — in writing — of the company's intention to buy the key person policy as well as the maximum face amount of that key person policy. Otherwise, the policy might not be issued.

Additionally, the company must obtain written consent from the key person. This written consent must acknowledge that the key person understands that a life insurance policy in a specific dollar amount is set to be taken out on them. This written consent must also state who will be paid and whether the policy will continue to exist if the key person is no longer employed by the company.

What does a company have to do if they want to take out key person insurance?

If a company wants to take out a key person insurance policy on someone, they must take the cost of the policy into consideration. This thought process will often hinge on the following factors:

• The amount of insurance that will be taken
• Whether the policy will be permanent life or term life
• The industry the business is in
• The structure of the business
• The gender and health status of the person who will be insured

How does key person insurance work out if the key person dies or becomes disabled?

If the key person dies or becomes disabled, the business can apply the proceeds of the policy to the expenses associated with paying off the business's debts or accounting for other costs associated with the loss of the key person. 

What if the key person no longer works for the company?

If the key person leaves the company, the business can choose to surrender the policy. In doing so, the company will have the option to either keep the proceeds or pay it out to the key person. No matter which of these options you choose, know that they are both taxable events. Alternatively, the company can keep the policy in effect or transfer it to the key person directly.

Benefits and considerations of key person insurance

There are many benefits to key person insurance, especially in the context of business continuity. However, there are also tax and financial considerations that could alter your decision.

For instance, the premiums for key person insurance are usually neither tax deductible nor considered business expenses. Rather, any cash value that builds as a result of the policy will grow tax deferred. This may provide you with an opportunity to borrow against the value of a permanent life policy.

As always, feel free to speak with your tax adviser to discuss whether key person insurance is a reasonable option for your business operations.

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