Key Man Insurance Explained: Coverage, Structure, and Tax Implications

Every business has that one person, or maybe even a few, whose knowledge, relationships, or leadership is critical to daily operations and long-term success. Unfortunately, if such an individual were to pass away unexpectedly, the financial disruption could be significant. That’s where Key Man Life Insurance (also called key person insurance) comes in.

What Is Key Man Life Insurance?

Key man life insurance is a policy that a business purchases on the life of a critical employee, such as an owner, founder, executive, or top salesperson. The business is both the policy owner and beneficiary, and it pays for the premiums. If the key person dies, the business receives the death benefit to help offset potential losses.

Who Needs It?

Key man life insurance is common in:

• Small and closely held businesses
• Startups seeking investor funding
• Firms with specialized talent or leadership
• Companies with loan agreements requiring coverage on executives

How Does It Work?

Let’s say a company’s founder is also its lead engineer, responsible for product design and client relationships. If she passes away, projects stall, client confidence drops, and revenue may decline. A key man policy provides the business with a financial cushion to:

• Offset lost revenue
• Satisfy lender or investor obligations
• Provide time to restructure or sell, if necessary
• Cover the cost of recruiting and training a replacement

Policy Types to Consider

Businesses can choose between:

• Term Life Insurance: More affordable, suitable for temporary needs (e.g., the length of a loan or business plan phase).
• Permanent Life Insurance: More expensive, but builds cash value and may serve dual purposes (e.g., funding buy-sell agreements or executive benefits).

Ownership and Tax Considerations

The business is typically the applicant, owner, premium payer, and beneficiary. Premiums are generally not tax-deductible, and death benefits are received tax-free under IRC §101(a), provided the policy is structured correctly and proper consent is obtained from the insured.

It’s also important to comply with COLI (Corporate-Owned Life Insurance) regulations, which require employee notification and written consent.

Note: Tax and legal implications vary. Always consult a qualified tax advisor or attorney to ensure your policy complies with applicable laws and fits your business objectives.

Final Thought

Key man life insurance isn’t just about replacing a person’s value; it’s about buying time and stability in the face of uncertainty. If your business depends heavily on one or two individuals, contact our office to explore how this coverage can protect your company’s future.