Most owners think about life insurance for their families. Fewer think about what happens to the business if an owner or a key employee dies or can’t work. Key person insurance is one way to plan for that.
This is general information, not legal or tax advice. Talk with your attorney and your CPA before you buy a policy for your business.
What key person insurance is
Key person insurance is a life insurance policy a business buys on someone whose loss would hurt the business. The business usually owns the policy, pays the premium and is the beneficiary. If that person dies, the business receives the money.
A key person is often an owner, but not always. It can be anyone whose skills, relationships or knowledge would be hard to replace quickly:
- The person who brings in most of the new work
- The person a major customer insists on working with
- The one who holds the licenses, bonding relationships or technical knowledge the business runs on
- The person who has personally signed for the business’s loans
What the money can do
The business decides how to use the money. Common uses include:
- Covering lost income while the business adjusts
- Recruiting, hiring and training a replacement
- Paying down business debt, or reassuring lenders and customers
- Giving the remaining owners time to decide what’s next
Don’t forget disability
A long illness or injury can hurt a business as much as a death. The Social Security Administration estimates that about 1 in 4 of today’s 20-year-olds will become disabled enough to qualify for Social Security disability benefits before age 67. More than 1 in 8 will die before that age. Key person disability coverage can pay the business if a key person can’t work, depending on the policy’s terms. Owners can also look at disability insurance that replaces their own income, and at coverage that helps pay business overhead while they recover.
Key person coverage and buy-sell agreements
A buy-sell agreement is a contract among a business’s owners, and sometimes the business itself. It sets out what happens to an owner’s share if they die, become disabled or leave. Life insurance is often used to fund it, so the remaining owners or the business have the money to buy the share from the owner’s family.
That’s a different job from key person coverage, even though both use life insurance. How the policies are owned and who the beneficiary is can change the legal and tax results. Your attorney and CPA should set up the agreement. We can help with the insurance that funds it.
When a lender asks for it
Some lenders ask for life insurance on a key owner as a condition of a business loan. The policy may be assigned to the lender as collateral, which means the lender is paid first, up to what’s owed. This is called a collateral assignment.
How much coverage?
There’s no single formula. Some questions to start with:
- How much income would the business lose in the first year or two without this person?
- What would it cost to find, hire and train a replacement?
- How much business debt would need to be paid, or would a lender call a loan?
- For a buy-sell, what is the owner’s share worth today?
Insurance companies will also look at the person’s role and the business’s finances when deciding how much they’ll offer.
An IRS rule to know first: notice and consent
When a business owns a life insurance policy on an employee, federal tax law has notice and consent rules. In general, before the policy is issued the employee must be told in writing that the employer plans to insure their life and for up to what amount, and that the employer will be the beneficiary. The employee must consent in writing, including to the coverage continuing after they leave the job.
These rules matter when a claim is paid. In general, the death benefit is left out of the business’s taxable income only if the notice and consent steps were done before the policy was issued and an exception in the law applies. Common exceptions cover a person who was an employee at any time in the 12 months before death, or who was a director or highly paid employee when the policy was issued. Others apply when the money goes to the person’s family or estate, or is used to buy the person’s ownership share from them. Otherwise, the part of the death benefit above the premiums the business paid may be taxable income to the business.
Businesses with these policies also generally file IRS Form 8925 each year. Ask your CPA to confirm the steps before the policy is issued.
Next steps
- List the people your business couldn’t easily do without.
- Talk with your attorney and CPA about buy-sell agreements and tax treatment.
- Talk with us about life and disability options, and how they fit your business continuity plan.
Sources
- 26 U.S.C. 101, including 101(j), Treatment of certain employer-owned life insurance contracts
- IRS, About Form 8925, Report of Employer-Owned Life Insurance Contracts
- IRMI, Key Person Life Insurance
- IRMI, Key Employee Insurance
- Social Security Administration, Fact Sheet
This is general educational information, not legal or tax advice. McGriff-Williams Insurance does not provide legal or tax services. Coverage, underwriting and tax treatment depend on the policy, the people insured and your situation.
Questions? A licensed member of our team can talk it through with you. McGriff-Williams Insurance is an independent insurance agency in Gainesville, in business since 1983 and licensed in Florida. We’re at 3501 W University Ave, Gainesville, FL 32607. Call (352) 371-7977, Monday to Friday, 9 a.m. to 5 p.m. You can also visit our life insurance page.
Where confidence grows.
Last updated October 31, 2026
