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What Small Business Owners Need to Know About Key Person Life Insurance

If you have a family, you probably know life insurance can help protect your loved ones financially if you pass away. But do you have life insurance to help protect your business?

Yes, there is such a thing: It's known as key person life insurance, and it's intended to help compensate your business if the business owner or another significant employee dies, according to the Insurance Information Institute (III).

Female and male business owners working behind coffee shop counter.

Key person insurance can make sense in many circumstances:

  • If the business' reputation and financial viability are critically linked to the key employee's name, reputation or unique skills; the key employee's death could end the business

  • If the death of a key employee (like a top salesperson) could quickly cripple the company financially.

  • If a financial institution or other creditor needs collateral for a business loan and requires the option of putting a lien on a key person policy (This is sometimes called collateral assignment.)

  • If the business is a partnership and each partner wants to be able to buy out the other's shares in case of an untimely death

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According to a survey by the National Association of Insurance Commissioners (NAIC), 71 percent of small business owners say they are "very dependent" on one or two key people for their success. Only 22 percent of the companies surveyed by the NAIC, however, had key person life insurance for their indispensable employees.

How Much Coverage Should I Buy?

There's no set formula for deciding the monetary value of your key person insurance, says the III. Inc. Magazine suggests that you start by considering the financial effects a key employee's death would have on your company.

For instance, if you're a sole proprietor buying key person insurance on yourself, you may want enough coverage to help your heirs close your business and pay off any company debts. If you own a larger company insuring a key employee, you may need enough coverage to replace that person's sales income, for example, or to provide a financial cushion while you search for the employee's replacement, according to Inc.

Who Owns the Key Person Policy and Who Benefits?

How your policy is structured can depend on your company's legal structure. Typically, the company pays premiums for the key person policy, and also owns it and is the beneficiary, says the III. The key employee must provide consent, in writing, to your company owning the policy.

Keep in mind that company-owned key person policies aren't a deductible business expense. But, as with other life insurance policies, the death benefit generally passes to the beneficiary (the company) tax-free1.

For more information about key person insurance, get in touch with an Allstate insurance agent.

1Death benefits and tax-deferred cash accumulation may be subject to the corporate Alternative Minimum Tax (AMT). The Pension Protection Act of 2006 limits the death proceeds an employer can exclude from income when insured does not meet the definition of a highly compensated employee or of a highly compensated individual. The Act also imposes specific requirements that the employer notify the individual about the insurance, secure his/her written consent and submit annual reports to the IRS.

Please note that Allstate Life Insurance Company or its agents andrepresentatives cannot give legal or tax advice. The brief discussion of taxes on thispage may notbe complete orcurrent. The laws and regulations are complex and subject to change. For complete details consult your attorney or tax advisor.

The statements above are for educational purposes only and not intended as specific tax advice. Allstate cannot provide tax or legal advice. Consult a tax advisor regarding your particular circumstances.

Life Insurance offered through Allstate Life Insurance Company, Northbrook, IL; Allstate Assurance Company, Northbrook, IL; Lincoln Benefit Life Company, Lincoln, NE and American Heritage Life Insurance Company, Jacksonville, FL. In New York, life insurance offered through Allstate Life Insurance Company of New York, Hauppauge, NY.

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