Benefits Of Key Man Life Insurance For Your Business 2024 Guide

last updated on November 25, 2023

Written by Daniel Ray, Life Insurance Expert | ✅ Fact Checked by

Lisamarie Monaco | Editorial Disclosure

The key man life insurance is a type of business insurance that protects the company in case one or more key employees are killed, disabled, or incapacitated.

There are many benefits to having this type of coverage for your business including protection from lawsuits and emotional damages; peace of mind knowing you’re covered against unforeseen circumstances, and savings on taxes because it’s an expense that can be deducted from your profits.

This blog post will provide you with insights on how best to use this kind of protection for your own company!

Article Navigation

Everything you need to know about a Key man Life Insurance Policy
Insurable Losses Under Key Man Insurance Policies
Deductibility Of Key man Life Insurance Premiums
Key man Insurance Definition
Taxation Of Keyman Life Insurance
Taxation Of Keyman Life Insurance Proceeds
Key Man Insurance Buy-Sell Agreement
Term Vs. Whole Life – Key Man Life Insurance
Key Man Income Protection Insurance
FAQs
Conclusion

Everything you need to know about a Key man Life Insurance Policy

Above all, when getting a keyman insurance policy for an employee you are looking to protect the company’s interest. After all, this employee is a tremendous asset to your bottom line.

What you will learn in this article is the importance of key man coverage, and how the loss of a key employee or top salesperson can be detrimental to business owners.

In fact, key employee insurance or key person life insurance is a term life insurance policy that will protect the small business from loss in the event of death or disability. Overall, the company pays the premiums and is the beneficiary so it is considered a form of business insurance. You protecting your asset in case of a loss.

For one thing, you are protecting shareholders or partnership interests as the loss of a key employee can be enormous. With regard to the old saying, 10% of your employees earn 80% of the business. In addition, it is also an income tax write-off for the company and the death benefit is tax-free.

The way key man insurance works are very simple. Normally the salary of the employee is multiplied or the amount of coverage is usually a million dollars. A key man insurance quote will be based on the current health of the employee. Then the insurance company will determine the rate class for the key person insurance policy. This in return will determine the price for the key man policy.

Read on further in more detail. This is just what’s in store in the rest of this article.

The Truth About Key man Insurance Policy, How It Can Protect Your Business

Every corporation has a key man. What is Key Man Life Insurance?

A superstar employee brings a lot to the table for any small business. He or she may be responsible for the big account at an advertising agency. Or an executive of a Fortune 500 corporation. Even the master mechanic at an auto shop.

All companies operate very differently. While some may spread the power evenly between departments, other companies may be highly dependent on just a couple of individuals.

Companies that have a few irreplaceable employees would be devastated if one of them were to pass away. So it is not uncommon to have a one million dollar policy or more for a key man.

The company may struggle to stay in business or strive to continue operating smoothly. Recent studies show that less than 15% of companies are prepared to handle the loss of key personnel.

It’s extremely risky to have an entire company be so dependent on just one or two individuals. For instance, this is where key man life insurance can help.

What Is Key man Insurance Policy

Key Man Insurance. Also known as Key Employee Insurance, Key Man Policy, or Key Person Insurance. Albeit, it’s not fun to prepare for the death of someone that you know on a personal level, businesses need to be protected just like people.

Business partners buy key man life insurance to protect the company from going down the tubes if they lose a key partner or employee. This is most commonly bought with a cheap affordable term policy.

Owners of smaller operations may cover themselves with life insurance to protect their families. A life insurance policy will take care of their debts, mortgage, and final expenses upon death. These permanent life insurance policies can cover business partners and key employees as well.

Another insurance that business owners buy is disability insurance which is typical for business partners. This insurance can also cover their Key employees. Disability insurance is meant to cover the expenses that occur after injuries or illnesses prevent people from returning to work.

Meanwhile, key man life insurance provides a different sort of coverage. Keyman life insurance covers businesses in the event that they lose one of their most important individuals.

This is sometimes part of a deferred compensation plan.

While key man life insurance is not for every company, there are some cases where not having key man life insurance is extremely risky. So from the business perspective standpoint, buying a key man would be considered as investing in the security of the business.

Insurable Losses Under Key Man Insurance Policies

When you own a business you can have considerable losses and/or put your company in financial hardship if a key employee dies or becomes disabled.

In fact, in some cases, key personnel are the glue that holds the bricks together and is vital to the success of the company.

Here are some of the losses that take place that a key man life insurance policy will protect:

Provide temporary personnel and, if necessary to finance the hiring and training of a replacement.
Insurance to protect the companies profits. For example, offsetting lost income from lost sales
Losses resulting from the delay or cancellation of any project that the key person was involved in.
Insurance to protect shareholders or partnership interests.

It is important to know that the key man insurance beneficiary would be the company.

Deductibility Of Key man Life Insurance Premiums

What to consider before you purchase key person insurance?

Well, you’ll need to determine whether or not your company is relying heavily on just a few individuals.

For example, the owner of the company is covered by key executive life insurance. Founders of a business may also be considered key people. In some instances, even some lower-level employees may be essential to the company.

Basically, you should decide whether or not your company would struggle to continue after the loss of an individual. If the answer is yes, the key man life insurance is a good investment.

Since every company operates differently, there is no universal rule. Instead, separately the company looks at deciding on which kind of coverage will be sufficient.

Key man Insurance Definition

How does key man insurance work?

Keyman life insurance actually functions quite similarly to regular life insurance. The business buys key man life insurance, and the business is also the beneficiary.

In order to maintain coverage, business partners need to pay the premiums.

If one of the people covered by a key man’s life insurance dies while the policy is intact, the business receives the pre-determined amount of money.

The amount can range from a few hundred thousand dollars to several million dollars.

These are the policies most used for a Key man:

Taxation Of Keyman Life Insurance

Is key man life insurance taxable?

Premiums are generally not tax-deductible in the U.S. Under the COLI Best Practices Act within the Pension Protection Act of 2006 unless it is part of the insured employee compensation.

As an employer-owned life insurance policy, the death benefit of the policy is tax-free as long as the premiums were paid with after-tax dollars. This means the business will get the full face value of the policy.

Above all, accounting for key man life insurance is very important.

Furthermore, a highly compensated employee at a small business is a pillar to that company, and having a personal life insurance policy on the key person is pivotal for the company’s success.

As far as the company, if a key person’s life insurance cash value is accumulated the company can borrow against it as a business loan that is not taxable.

This is one of the many benefits the company has when putting this type of policy in place.

Taxation Of Keyman Life Insurance Proceeds

Are Key Employee Life Insurance Proceeds Taxable?

Above all, is a key man life insurance proceeds taxable? Under certain circumstances, they can be.

For example, if a company has paid into the policy and the cash value has grown far and beyond the premiums paid and they cash out this could trigger a taxable event.

Again, the premiums paid are not tax-deductible unless they are part of the key person’s compensation package.

Key Man Insurance Buy-Sell Agreement

A big question I hear sometimes is can a key man be a partner in a business?

The answer is an absolute yes.

For example, if you have two partners and one said the money guy and the other was the key man that went out and brought in the business they both have a very important part to partake in.

Now if one dies then the surviving partner when inheriting the business. But what about the family of the deceased partner?

Over the short term, this could be a problem. The last thing you want is legality issues such as a pissed-off family suing for control of a company they know nothing about.

So a buy-sell agreement takes care of this.

Part of the key man policy is the notice and consent requirements. This outlays the laws defined in the agreement. These include but are not limited to:

The owner engages in a trade or business, and
The owner (or a related party) is a beneficiary (direct or indirect), and
The insured is an employee at the time of policy issue, and
The insured is a U.S. citizen or resident.

Now to fund a buy-sell agreement it has to be in agreeance between the partners. it is also not uncommon to change these from time to time because of a buyout or to find a replacement if it’s a key man.

Examples of Key Employees

The Owner of a company or partners
The “go-to” guy/top salesman or a manager under the owner

Key Man Life Insurance Considerations

Consider coverage terms and limits
Term vs Whole Life (we will discuss this below)
As your business grows, your coverage limits may change. Be flexible!
Consider adding a Business Exchange Rider. This is where you would have an option to replace your Key Person with a new Key Person if need be.

Term Vs. Whole Life – Key Man Life Insurance

How much does key man insurance cost? This will determine what type of product you use for the key person insurance quote.

In most cases, a 10yr term is used to cover a key person. However, most deferred compensation plans will use a permanent life policy like a whole life.

Term:

Key man Term Life insurance is a cheap affordable option for your business. Options for the term range from 10, 20, 30 years. Also, you might want to look into a term policy with living benefits in lieu of a disability policy.

Ask your Agent about a company that will offer up to $1,000,000 no exam coverage for a key employee. Therefore, this is an option if your key employee does not wish to take an exam.

Keep in mind, there are many options ranging from $20,000, $500,000, or up to a million. Ask your agent to guide you. The more honest and detailed the information you give him/her, the better they can guide you through the process.

Whole Life:

Whole life insurance builds cash value and will last the lifetime of the insured. In fact, a benefit of cash value life insurance will allow you to access the funds via tax-free policy loans.

This is sometimes called infinite banking. Think about it this way, it is an added incentive for your key person to stay with your company until his or her policy has fully matured. Not to mention, add liquidity to your business.

Call your Agent to ask about term vs whole life insurance and to go over your keyman life insurance rates. In addition, ask about Single Premium Whole Life

Key Man Income Protection Insurance

How Much Key Man Insurance Should I Have?

The amount depends on how much the company pays in premiums so it’s always smart business to shop around for the best insurance quotes.

Therefore, successful businesses with bigger budgets can afford better coverage. This works out since more successful businesses have more to lose, which means they should definitely consider getting proper protection.

Before deciding on how much you want to pay in premiums, you should decide how valuable the person you covering is to the company.

It’s usually a good idea to follow the same general rule for standard life insurance; the figure should probably be at least 5 to 10 times the person’s salary.

You also need to consider how much money it will cost to hire a new person to fill the position, or how much it will cost to fulfill their duties without them.

Of course, these factors require a decent amount of calculations.

Hiring an independent insurance agent can help people and businesses find the best and most affordable coverage.

An independent insurance agent can connect you with the top life insurance companies. On top of this, they can answer any questions or concerns.

Top Key Man Life Insurance Carriers

Protective
Banner
Prudential
John Hancock
AIG

Key Man Life Insurance Underwriting

Your independent agent can guide you with what to expect during the application and underwriting process, but generally, underwriters of key man insurance want to know the following:

What type of business you are operating
The role of the key person ~ not everyone is considered valuable enough to hold key person titles.
What skill set the key person has, and experience in that skill ~ the more experience, the more vital role they play in the business.
Income ~ this helps to determine how much coverage is needed.

Above all, a health history will determine key man insurance cost.

FAQs

How does key man life insurance benefit a business?
This insurance provides financial stability by compensating the business for monetary losses that occur if a key person dies unexpectedly, helping to cover lost revenue, recruitment, and training costs for a replacement.

Who can be considered a key person for this insurance?
A key person can be anyone directly associated with the business whose loss would cause significant financial strain to the company. This includes executives, key salespeople, or individuals with unique expertise.

Is key man insurance a legal requirement?
It’s not a legal requirement but is often considered essential for business continuity planning, especially for small and medium-sized businesses.

How is the insurance premium calculated?
Premiums are typically based on the key person’s age, health, the role in the company, and the amount of coverage required.

Can the business use the insurance payout for any purpose?
Yes, the payout can be used to cover various costs such as recruiting a replacement, debt repayment, or even as working capital.

Are there tax benefits associated with key man insurance?
The tax implications can vary based on regional laws. Generally, premiums are not tax-deductible, but the payout is often received tax-free.

How does key man insurance differ from personal life insurance?
Key man insurance is owned by the business, and the business is the beneficiary, unlike personal life insurance where the policyholder’s family is the beneficiary.

Can a company have key man insurance policies on multiple employees?
Yes, businesses can insure more than one key person as needed.

What factors should a business consider when choosing the amount of coverage?
Factors include the key person’s impact on the company’s revenue, the cost of finding and training a suitable replacement, and the amount of time it might take to recover from the loss.

Conclusion

So, what should you do? Get a key man insurance policy! It’s the best way to protect your company and it’s clear that it is absolutely worth every penny. Contact our office today for more information about our policies or fill out an online quote request form so we can get started helping you find the coverage that works for your business. We know there are many options available when shopping around for these types of policies but remember-we’ve got everything in one place with competitive pricing!