Key Man Insurance: Protecting A Business From Losing A Vital Employee

Shawn Plummer

CEO, The Annuity Expert

What is Key Man Insurance?

Key Man Insurance, also known as Key Person Insurance, Key Employee Insurance, or Key Man Life Insurance, is a type of business insurance policy. It provides financial protection to a company in the event of the death or disability of a key employee whose skills, knowledge, or contribution is vital to the business’s continued financial success.

Types of Key Employee Insurance

  1. Key Man Life Insurance: Covers the life of a key employee. If the key employee passes away, the company receives the insurance benefit.
  2. Key Person Disability Insurance: Provides financial support to the company if the key employee becomes disabled.

What Is The Purpose of Key Person Insurance?

The primary purpose of Key Person Insurance is to safeguard the business from the financial impact of losing a crucial team member. This can include covering the costs of:

  • Temporary staff or training for a replacement.
  • Lost profits due to the absence of the key person.
  • Loan protection if the key person was crucial for securing business loans.

Types of Life Insurance Used for Key Employee Indemnification

Typically, Term Life Insurance and Whole Life Insurance are used for Key Man Insurance. Term Life Insurance is popular due to its lower cost and specified coverage period, aligning with the employee’s tenure. Whole Life Insurance offers lifelong coverage and accumulates cash value, which can be an asset to the business.

Ownership and Beneficiary Details

In Key Person Insurance:

  • Owner: The business owns the policy.
  • Beneficiary: The business is also the beneficiary, receiving the insurance payout if the key person dies or becomes disabled.

Key Person Disability Insurance

Key Person Disability Insurance offers coverage if a key employee becomes disabled, safeguarding the business during their recovery period or adjustment phase for a new replacement.

How Much is Key Man Insurance?

The cost of Key Man Insurance depends on factors like:

  • The key employee’s age, health, and lifestyle.
  • The coverage amount needed.
  • The type of insurance policy chosen (Term or Whole Life).
  • The specific role and importance of the employee to the business.
Key Employee Insurance

Key Person Life Insurance Vs. Disability Insurance

FeatureTerm Life InsuranceWhole Life InsuranceDisability Insurance
Coverage DurationFixed term (e.g., 10-20 years)LifelongAs per policy terms
CostGenerally lowerHigher due to lifelong coverage & cash valueVaries based on coverage
Cash ValueNoYes, accumulates over timeNo
PurposeDeath benefitDeath benefit + Investment componentDisability coverage
SuitabilityShort-term, cost-effectiveLong-term, with financial assetCovering disability risks

How Does It Differ from Other Life Insurance Policies?

While terms like group life insurance or term life insurance may sound familiar, key man insurance is distinct.

  • Key Person’s Contribution: The primary focus here is on the individual’s importance to the business rather than the person’s salary or employee’s compensation.
  • Beneficiary: Unlike other life insurance policies where family members typically benefit, the business owns and is the direct beneficiary in key man insurance.

Example: An insured employee in a small business with a term life insurance policy will have their family receive the death benefit upon their demise. In contrast, with a key man policy, the business gets the payout if the key employee dies.

Related Reading: The Section 162 Executive Bonus Plan

Key Person Insurance

Eligibility, Benefits, and Tax Implications

  • Businesses can choose which key employees to insure.
  • The policy can also be part of the employee’s non-qualified deferred compensation plan, with the cash value potentially used as retirement income.
  • Life insurance proceeds are generally tax-free. However, specific conditions must be met under the Internal Revenue Code.
  • Premium payments are not tax-deductible.
  • It offers a financial cushion, helping the business cope with the loss of profits or increased costs following the key person’s death.
  • It reassures creditors and suppliers about the company’s stability.
  • It can be used to recruit and train a replacement.
  • If the key person is also an owner, the funds can help purchase the deceased’s interest from their heirs, ensuring business continuity.
Key Man Insurance

Next Steps

Certain threads – or key persons – hold it all together in the intricate tapestry of business operations. Key man insurance is an indispensable tool in ensuring that the abrupt loss of such an individual doesn’t spell doom for the company. As with any financial decision, it’s paramount to research, consult with financial professionals, and consider the unique needs of your business. With key man insurance, companies can shield themselves from the unpredictabilities of life, ensuring that they continue to thrive even in the face of adversity.

Key Man Life Insurance And Key Man Disability Insurance

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Frequently Asked Questions

Who benefits from key man insurance?

A key man insurance policy primarily benefits businesses relying on a few critical individuals for success. If one of these key people passes away or becomes incapacitated, the policy provides a financial safety net, helping the company navigate the transition and potentially avoid dissolution.

What is key man risk?

Key man risk refers to a business’s vulnerability when its success is highly dependent on a single individual, often a founder or top executive. If this “key man” leaves or becomes incapacitated, it could significantly impact the company’s performance, stability, or future growth.

Shawn Plummer

CEO, The Annuity Expert

Shawn Plummer is a licensed financial professional, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

The Annuity Expert is an independent online insurance agency servicing consumers across the United States. The goal is to help you take the guesswork out of retirement planning and find the best insurance coverage at the cheapest rates

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