The short answer
A business usually sizes key person insurance with one of a few methods. Common ones are a multiple of the person's pay, the profit the business would lose, or the cost to recruit and train a replacement. Debts the person has signed for count too. Insurers then check that the amount fits the role.
This guide answers the most common questions about key man insurance for buy sell agreement.
Key person coverage only helps if the amount fits the real impact of a loss.
Here is how to size it with confidence.
Part of our complete guide: Key Person Insurance: The Complete Guide.
Quick answer
Use compensation, profit contribution, replacement cost or debts as a base. Insurers check that the amount is reasonable for the business. Pick a term that covers a realistic transition period.
MarketView Agency is an independent insurance agency (National Producer Number 18345705).
On this page
- Key man insurance for buy sell agreement: how key person insurance is taxed
- Key person insurance amount: is key person coverage the same as a buy-sell policy?
- How key person insurance works
- Key person insurance quotes for small business: why small businesses need it most
- How to get it, step by step
- A worked example
- How insurers decide your rate
- Who key person insurance is for
- Frequently asked questions
Key man insurance for buy sell agreement: how key person insurance is taxed
In general, premiums on key person insurance are not tax-deductible when the business is the beneficiary. In exchange, the death benefit is generally income-tax-free to the business, provided the notice and consent rules in federal tax law for employer-owned life insurance are met before the policy is issued.
Those rules require written notice to the insured employee and their written consent, plus annual reporting. Missing them can make part of the benefit taxable.
Business tax rules are detailed. Work with your tax professional before you buy.
Key person insurance amount: is key person coverage the same as a buy-sell policy?
Key person insurance and buy-sell funding are often confused. Key person coverage protects the business's operations. Buy-sell funding pays for a change in ownership, according to a written agreement.
If you have partners, talk with an attorney about a buy-sell agreement and use life insurance to fund it.
Compare rates from several carriers in about two minutes. Free, no obligation.
How key person insurance works
Key person insurance is life insurance a business buys on an owner or employee whose loss would seriously hurt the company. The business owns the policy, pays the premium and is the beneficiary.
If the key person passes away, the business receives the death benefit. It can use the money to replace lost revenue, recruit and train a successor, pay off business debts or reassure lenders and clients during the transition.
Key person insurance quotes for small business: why small businesses need it most
Large companies can absorb the loss of a key person. Small businesses often cannot. Key person insurance buys time and options when the business needs them most.
How to get it, step by step
- Work out the amount and term you need (debts, income, years).
- Compare quotes from several carriers.
- Apply: health questions, and sometimes a short exam.
- Review the policy when it arrives; you can return it during the free-look period.
How to get covered in 3 steps
- Pick who to cover and how much. Use a clear valuation method for the person's role.
- Compare carriers. An independent agent quotes several insurers and handles notice and consent paperwork.
- Apply and set up ownership. The business owns the policy, pays the premium and is the beneficiary.
A worked example
Say you're 34 with a $150,000 mortgage balance and 16 years left, $19,000 in other debts, and an income of $55,000. Here's one simple way to size coverage:
| Item | Amount |
|---|---|
| Mortgage balance | $150,000 |
| Other debts | $19,000 |
| 4 years of income | $220,000 |
| Total to consider | $389,000 |
In this example, a 20-year term would outlast the loan (it ends around age 54). Your own numbers will differ; use this as a starting point and adjust for savings, other coverage and future costs like school.
How insurers decide your rate
Underwriting is how an insurance company decides whether to offer a policy and at what price. It sounds technical, but the idea is simple. The insurer wants a clear picture of your health, your habits and how much coverage you are asking for.
The application
You answer questions about your age, height and weight, tobacco use, medical history and prescriptions. Answer every question fully and honestly. A wrong answer can give the insurer grounds to contest a claim later, especially in the first two years of the policy.
Database checks
Most insurers check prescription history and a shared industry database of past applications. Many also look at your driving record. These checks are why some policies can skip a medical exam: the records answer many of the same questions.
Exam or no exam
Some policies ask for a short exam at home or work, usually a quick health check and a blood and urine sample. Others decide from your answers and records alone. A policy without an exam is faster, but it can cost more or cap how much coverage you can get.
Once the insurer finishes, it offers a rate class. Healthier applicants get better classes and lower rates. If the offer is higher than the quote, an independent agent can often take the same application to another carrier that views your history more kindly.
Who key person insurance is for
Often a good fit
- Companies where one or two people drive sales, hold key client relationships or have know-how that would take months to replace, and businesses with loans tied to an owner.
Maybe not the right fit
- Companies with deep benches where any role could be covered quickly, or with enough reserves to absorb a long transition.
