What Is Key Person Insurance?

A life or disability policy the business buys on an employee whose loss would cause financial harm The business owns the policy, pays premiums, and receives the payout — not the employee's family It covers recruiting a replacement, lost revenue, debt repayment, or even an orderly wind-down Think of it as a financial bridge while the business recovers from losing a critical person

Any business where one or two people drive most of the revenue, client relationships, or know-how Startup founders — investors and lenders often require key person policies as a condition of funding A top salesperson managing the biggest accounts or a lead engineer with critical expertise Professional services firms where clients follow individual practitioners, not the firm

Premiums are not tax-deductible — the IRS does not treat them as a deductible business expense Death benefit proceeds are generally income-tax-free if notice and consent requirements are met Employers must notify employees in writing and get consent before purchasing a policy on their life If the policy is transferred to another party, the death benefit may become partially taxable

Key person insurance protects against the financial shock of losing someone who drives major value Coverage should reflect lost revenue, replacement costs, and any debt tied to the key person Term insurance is right for most businesses — affordable and sized to the period of greatest risk Review coverage annually as the business grows and talent concentration shifts

Key Person Insurance: Protecting Your Business from Talent Risk

Who Needs It?

Any business where one or two people drive most of the revenue, client relationships, or know-how
Startup founders — investors and lenders often require key person policies as a condition of funding
A top salesperson managing the biggest accounts or a lead engineer with critical expertise
Professional services firms where clients follow individual practitioners, not the firm

Determining the Coverage Amount

Start with the revenue the key person generates — a common benchmark is 5–10x their compensation
Add the cost to recruit, hire, and train a replacement, which can take 6–18 months for senior roles
Include any loans or obligations that depend on the key person's involvement
Estimate client revenue at risk if major relationships would leave with the person over 2–3 years

Term vs. Permanent Policies

Term life is most common — straightforward, affordable, and matched to a specific time horizon
A 10 or 20-year term works well when the key person's importance will diminish over time
Permanent (whole/universal) life builds cash value on the balance sheet as a long-term asset
Most small businesses choose term for simplicity — permanent policies suit buy-sell or executive plans

Tax Treatment

Premiums are not tax-deductible — the IRS does not treat them as a deductible business expense
Death benefit proceeds are generally income-tax-free if notice and consent requirements are met
Employers must notify employees in writing and get consent before purchasing a policy on their life
If the policy is transferred to another party, the death benefit may become partially taxable

When to Reassess Coverage

Review policies annually — the people who matter most to the company can change over time
If a key person leaves or moves to a less critical role, the policy may no longer be needed
As the business builds management depth, the risk of losing any single person decreases
New funding, acquisitions, or market expansion may create new key person risks to cover

Key Takeaways

Key person insurance protects against the financial shock of losing someone who drives major value
Coverage should reflect lost revenue, replacement costs, and any debt tied to the key person
Term insurance is right for most businesses — affordable and sized to the period of greatest risk
Review coverage annually as the business grows and talent concentration shifts

What Is Key Person Insurance?

Who Needs It?

Determining the Coverage Amount

Term vs. Permanent Policies

Tax Treatment

When to Reassess Coverage

Key Takeaways

Related Topics

Buy-Sell Agreements: Protecting Business Owners and Partners

Financial Planning for New Parents

Term Life Insurance

What Is Key Person Insurance?

Who Needs It?

Determining the Coverage Amount

Term vs. Permanent Policies

Tax Treatment

When to Reassess Coverage

Key Takeaways

Related Topics

Buy-Sell Agreements: Protecting Business Owners and Partners

Financial Planning for New Parents

Term Life Insurance