Key Man Life Insurance: What Is It? How Does It Work?

Shawn Plummer

CEO, The Annuity Expert

Critical man life insurance is a policy that provides financial protection for a company if one of its key employees dies. This type of insurance is essential for businesses because it can help ensure the company can continue operating after losing a key employee. This guide will discuss critical personal life insurance and how it works. We will also examine some benefits businesses can receive from purchasing this policy.

What is Key Man Life Insurance?

Keyman life insurance is a corporate-owned life insurance (COLI) used to protect a business’s employees’ lives. It’s intended to aid a firm in recovering from losing an employee who contributes significantly to the company if they die. Top salespeople, high-level executives, and other decision-makers,

Keyman policies have three primary roles:

  • Owner: The person or entity purchases the life insurance policy and pays the premiums. The owner can sell, transfer, or alter the policy terms.
  • Insured: The policyholder on whose death the death benefit is payable. As a result, premiums are directly linked to the insured’s health and lifestyle.
  • Beneficiary: The recipient of a death benefit is the person or entity who would get the money if the insured died during the term of coverage.

The key man life insurance policy differs from other life insurance plans in that the business is both the owner and beneficiary of the coverage.

The employee has practically no say in the policy. However, before purchasing it, the company must notify the employee of its intention to acquire insurance, provide information on the policy, and get written permission.

You may complete all this using an Employer Owned Life Insurance Acknowledgement and Consent Form.

What Is Key Man Life Insurance?

How Does Key Man Life Insurance Work?

When a key employee dies, it can significantly impact a company. Losing a key employee can decrease productivity, lose customers, and even cause business closure. Keyman life insurance can help to offset these losses by providing financial protection for the company.

The death benefit from a key man life insurance policy can help cover the costs of replacing the key employee and any other expenses the company incurs due to their death. The policy can also be used to provide financial stability for the family of the deceased employee.

There are two main types of critical man life insurance: term and whole life insurance. Term life insurance covers a set period, typically ten to forty years. Whole life insurance provides coverage for the entire life of the policyholder.

Businesses can purchase key man life insurance policies for their employees. The death benefit from these policies can help the company cover the costs of losing a key employee.

Free Guide: How Key Man Insurance Works With Life Insurance

Life Insurance Types That Can be Used as Key Man Life Insurance?

Any life insurance policy can be structured as critical man life insurance.

  • Term life insurance: Term life insurance covers you for a certain amount of time, ranging between 10 to 40 years. It is less expensive than permanent life insurance. For example, some people have key man policies tied to their retirement date.
  • Permanent life insurance: Permanent life insurance provides lifelong coverage. A portion of permanent life insurance premiums is paid into a cash-value account, which appreciates over time. The cash value of a policy is an asset that may be used as collateral for a loan and, if a mutual insurance company issued the policy, would allow the firm to receive dividends. In addition, permanent life insurance policies accumulate value over time, allowing them to be sold in a life insurance payout if the employer decides it no longer requires coverage.

Permanent life insurance is expensive, and the company’s needs can change. Term coverage is often used for keyman life insurance. Permanent life insurance can be structured as an employee benefit if the policy and its cash value can be transferred to the insured after a certain number of years or at a particular milestone.

No matter what kind of life insurance you get, ensure it is flexible. For example, adding a business exchange rider to a permanent policy allows you to change the person insured should that employee leave the company. Similarly, many critical executive life insurance policies will enable you to periodically increase or decrease the policy’s limits, as the needs of

When would your business need keyman life insurance?

Banks and the SBA often require keyman life insurance for loans or investments. This is because it could be hard for a small company to survive without one or two employees. The same can happen with investors, so they might want assurance that losing those people wouldn’t bankrupt the company.

Companies buy keyman life insurance to protect themselves from losses. If someone from the company died, it would affect how much money they make to buy this type of insurance. Examples include:

  • The company’s brand is tied to the name of one person.
  • The company’s performance is affected by the skills of employees. Projects are often linked to their abilities.
  • If an employee leaves, the business might lose customers.
  • If the company loses an employee, it will affect their credit or cause a business loan to become due.

If someone in your company is essential and if they were to die, your company might not survive. If that happens, you can use a “key man policy” to pay any debt the person has left behind. The critical man policy will also give some money back to investors in the business.

Critical executive life insurance also can be used as an incentive for an employee to stay with the company. For example, they can buy a permanent life insurance policy they will get when they retire. Or you could give it to them after a certain number of years or if they do well at their job.

Keyman insurance is an excellent way to have money for your family if you die. However, you can’t have this if you are a sole proprietor and the only one who works in your company. So, consider getting a personal life insurance plan for yourself and your family.

Helpful Tip: If you need affordable insurance for your business, we recommend the following:

Keyman Life Insurance

How Much Life Insurance Do You Need as a Key Man?

If you borrow money, the lender may want to repay the loan. You will need different amounts of critical man insurance depending on how much your business relies on the person and what kind of employee they are. It is best to buy enough critical man insurance to avoid negative impacts if they cannot work anymore.

If you want to ensure a top salesperson, seeing how much revenue they create is easy. But when you want to insure a CEO, we cannot know the value of their work.

While none are perfect, a few of the most frequently employed techniques for determining the required amount of critical executive life insurance are:

  • Multiple Compensation: The compensation of the employees is multiplied by how many years it will take for the company to replace them. This estimate is problematic because it assumes that their value to the company is reflected in their salary.
  • Percentage of Revenue or Profits: Revenue or profit is multiplied by the years it might take to replace an employee. It depends on the company and its structure.
  • Cost to Replace: The cost of finding, hiring, and training a new person to replace someone who left for some reason. You should include the amount of money you will lose during this time in your calculations.

Even though crucial employee life insurance is mainly bought for high-earners, the face amount is frequently limited to a multiple of the insured’s income, such as 10X. Even so, depending on the insurer and your company structure, your annual bonus or a portion of the firm’s net income may be included in your employee’s income.

Key Man Life Insurance Tax

The cost of critical man life insurance, which is not tax-deductible, must be paid with after-tax dollars. However, sometimes companies can deduct the cost if it means that the employee’s taxable income increases.

Most of the time, the death benefit of a keyman policy is paid without income tax if the insured person dies. The only exception is for C corporations, for which the death benefit will be included in the AMT calculation.

You might pay taxes if your company decides to sell the key person’s life insurance policy. It depends on how much they have paid in premiums.

The company must include information about the coverage with its corporate tax return each year. This includes how many employees are insured, how much coverage they have, and if they permit the policy to be purchased.

Tax Treatment for Employees

If your company is the only owner and beneficiary of a key person’s life insurance policy, there are no tax implications for the insured employee. However, if you transfer ownership of the key man policy to the employee, they may have to pay taxes because it could be considered compensation.

Cost of Key Man Life Insurance

Keyman life insurance premiums are determined by a variety of factors, including but not limited to the following:

  • Type of policy purchased: Term life insurance is less expensive than permanent life insurance. Term life insurance policies are for a set amount of time and do not accumulate any cash value. Permanent life insurance policies have different costs, risks, and benefits.
  • Policy death benefit: The more coverage you have, the more expensive it will be.
  • Employee’s health and lifestyle: There are different levels of risk that you can have. These depend on someone’s age, medical history, hobbies, occupation, family history, driving record, and general health. This will affect the premium they have to pay for insurance.

It is essential to know that critical man life insurance can be expensive if you are trying to insure an older or less healthy employee. You might not even be able to find coverage for your crucial employee. Utilizing a deferred annuity in Section 162 Executive Bonus Plan or finding a replacement could be a backup plan.

Helpful Tip: If you need a cheap service to set up your entire estate plan, we recommend:

Life Insurance For Business Owner

Next Steps

Critical man life insurance can be a valuable tool for businesses that want to protect themselves from the financial impact of losing a key employee. This type of policy can help to ensure that the company can continue operating after the death of a key employee and can also help to offset the costs associated with losing a key employee.

Request a quote for critical man life insurance today to get started on coverage for your business. Critical man life insurance can help provide financial protection if a key employee dies and can ensure that your company can continue operating after such a loss. Get started on a policy today to give your business the peace of mind it deserves.

Key Man Life Insurance And Key Person Life Insurance

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Frequently Asked Questions

Is key man life insurance taxable or tax-deductible?

A key man policy can be an employee benefit to the company if the company pays for it with tax-free money. The premiums are not tax-deductible, but your family will get the money from the policy without any taxes taken out of it when you die.

What is the meaning of critical man insurance?

Keyman insurance is a policy where the employer serves as both the proposer and premium payer. In this case, the life to be insured belongs to an employee; however, all benefits received from a successful claim go directly back to the employer.

What are the disadvantages of critical man insurance?

Keyman insurance can have some drawbacks, including that the amount paid out upon a claim or maturity is not exempt from taxation under Section 10 (10D) of the Income Tax Act if your company pays for premiums.

What is the difference between critical man insurance and life insurance?

Group life insurance covers an enterprise’s employees, offering identical benefits to every member. Conversely, keyman insurance shields only a specific individual that is the policyholder.

Do you need critical man insurance?

If your small or medium-sized business relies on one or two people, don’t underestimate the importance of Key Man Insurance. Losing a key team member will not only have an emotional toll on employees but cause profound financial implications as well – be prepared and secure yourself with adequate coverage!

*Disclosure: Some of the links in this guide may be affiliate links. I may receive a commission at no cost to you if you purchase a policy. It helps us keep the lights on!

Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

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

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