A Guide to Life Insurance for Small Business Owners

Key Person Life Insurance

Key person insurance is insurance a company buys on an employee. The company is both the policy owner and beneficiary.

A “key person” is essential to the success of your business. If this person died, your business would feel the impact.

With key person life insurance, if this person dies, the business receives a payout from the insurance company. The death benefit is often used to cover losses and to find and train a replacement.

Business owners may need key person life insurance for the following reasons:

If your business’s reputation is linked to the key employee’s name, standing, or unique skills.
If your business is a partnership and each partner wants to be able to buy out the other’s shares in case of an untimely death.
If your business is seeking investors or SBA loans, and lenders are only willing to sign contracts if life insurance is on the key people.
If the death of a key employee creates financial problems for the business.

Both term and permanent life insurance can be used as key person life insurance.

If you need key person insurance for a specific period, for example, if you only need it to last until that employee’s expected retirement year, term life insurance is ideal. Permanent life insurance may be the better choice if the key person is an owner or partner and you want to access cash value for future expenses.

Learn more: Key Person Life Insurance: What It Is & How It Works

Funding for Buy-Sell Agreements

A buy-sell agreement is a contract between a business owner and a person or entity who agrees to buy the owner’s interest if the business owner dies. The purchase price is agreed upon and stated in the buy-sell.

Life insurance is one of the primary methods used to fund this transaction.

The buyer in the buy-sell agreement buys life insurance on the seller (with the seller’s consent) in an amount equal to the pre-arranged purchase price. When the business owner (a.k.a. the seller) dies, the buyer purchases the deceased owner’s interest from their estate.

Business owners may need a buy-sell agreement funded with life insurance for the following reasons:

It protects the business owner’s heirs and ensures the business ends up in the hands of someone willing and capable of running it.
It establishes a fair and reasonable price for the business.
It helps fix the value of the deceased’s interest for federal estate tax purposes.
If applicable, the policy’s cash value can be accessed for business uses.
Cash is available for estate liquidity or other family needs.
It helps prevent legal battles and contestation.

Both term and permanent life insurance can be used to fund a buy-sell agreement.

Term life insurance is a good option if the agreement is expected to end by retirement age. Permanent life insurance is a good option if the seller is young and the agreement is expected to be in place for some time.

Learn more: Buy-Sell Agreements: What Are They & How Do They Work?

Inheritance Equalization

If you have children and run a small business, perhaps some children are interested in the business while others aren’t. If you’re concerned about leaving behind something for all of your heirs, life insurance can help.

For example, let’s say you have two children. One works in the family business, and one branched out. Using life insurance in your estate plan can ensure the child who wants to take over the family business can, and your other child receives an insurance payout.

Individual Life Insurance for Small Business Owners

Business owners often have at least two different life insurance policies: one that is business related, such as tied to a buy-sell agreement, and one that is primarily for their family.

An individual life insurance policy is one that you own. Business owners use life insurance to protect their loved ones’ financial futures.

If you have loved ones relying on your income, the death benefit from a life insurance policy can replace this income if you die unexpectedly.

For individual life insurance, the rule of thumb is that you should buy coverage equal to 10 times your income. But this amount isn’t right for everyone. For a better estimate, use our free life insurance calculator.

Benefits of an individual life insurance policy:

You own it outright, and it’s not tied to anyone else.
You choose the beneficiaries and how big of a payout they receive.
The policy’s death benefit is paid out income tax-free.
Life insurance will avoid probate, so your beneficiaries are paid faster.
Life insurance protects your family’s standard of living.

A disability can also significantly impact a business. Learn how disability insurance protects business owners.