What is the primary purpose of key person life insurance?

The primary purpose of key person life insurance is to protect a business from the financial losses that would occur due to the unexpected death or disability of a crucial employee or owner. The death benefit provides funds to cover operational disruptions, recruit a replacement, or offset lost revenue.

How much key person life insurance does a business typically need?

The amount of key person life insurance needed varies widely but is often calculated based on the key person's contribution to revenue, their replacement cost, and the potential impact of their absence. Common guidelines suggest coverage of 2 to 10 times the key person's annual salary, or a figure based on their direct profit contribution.

Are life insurance premiums for business owners tax-deductible?

Generally, life insurance premiums paid by a business are not tax-deductible if the business is the beneficiary of the policy (e.g., key person insurance, entity-funded buy-sell). However, there are exceptions, such as executive bonus plans where premiums are taxable income to the employee but often deductible by the business. Always consult a tax advisor.

What happens if an owner leaves the business but doesn't die?

A well-structured buy-sell agreement should outline what happens in various scenarios, including an owner's voluntary departure, retirement, or disability. While life insurance covers death, disability insurance is often used to fund buyouts in the event of an owner's incapacitation. The agreement specifies the terms for purchasing the departing owner's shares in these situations.

Can a business owner use their personal life insurance for business needs?

While technically possible to assign personal life insurance as collateral for a business loan, it's generally not advisable for other business needs like key person or buy-sell funding. Using dedicated business policies clearly separates personal and business finances, simplifying tax implications, ownership, and beneficiary designations, and protecting personal beneficiaries from business obligations.

What is the difference between a cross-purchase and an entity purchase buy-sell agreement?

In a cross-purchase agreement, each owner buys a policy on the other owners, and the surviving owners use the death benefit to buy the deceased's shares. In an entity purchase agreement, the business itself buys a policy on each owner, and the business uses the death benefit to redeem the deceased owner's shares.

How often should a business owner review their life insurance policies and buy-sell agreements?

Business owners should review their life insurance policies and buy-sell agreements at least annually, or whenever there are significant changes to the business (e.g., new partners, major acquisitions, substantial growth, new loans) or to an owner's personal circumstances (e.g., marriage, divorce, birth of a child).

Life Insurance for Business Owners | One Percent Finance