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Key Person Insurance and Your Estate Plan: What UK Business Owners Need to Know

· 16 min

Note: The following scenario is fictional and used for illustration.

James, 47, built his IT consultancy from scratch over 15 years. The business was now worth £1.2 million, employed 12 people, and had two other shareholders. James had done the "responsible thing"—he'd taken out £500,000 of key person insurance to protect the business if anything happened to him. He thought he was covered.

When James's accountant asked to see his will during a business review meeting, James admitted he didn't have one. "But I've got the key person insurance," he said. "Isn't that enough?"

His accountant's response shocked him: "That insurance pays the company, not your family. If you die tomorrow, your wife inherits your 60% shareholding under intestacy rules—but she'll have no say in how the business uses that £500,000 payout. And without a shareholder agreement, the other shareholders could make decisions she disagrees with."

James had confused business protection with personal estate planning. He wasn't alone. Research from Legal & General shows that 52% of SMEs would cease trading within a year following the death or illness of a key employee, yet many business owners don't understand how this insurance interacts with their personal will.

This guide explains how key person insurance, shareholder agreements, and your will work together to protect both your business and your family.

Table of Contents

What Is Key Person Insurance and How Does It Work?

Key person insurance is a life insurance policy owned by your business that pays out if a key employee dies or becomes critically ill. The business pays the premiums and receives the lump sum.

Without this protection, 26% of UK SMEs would close immediately if a key person died or became critically ill. The insurance replaces lost revenue, covers recruitment costs, and maintains stakeholder confidence.

Sarah runs a dental practice generating £300,000 annually. She took out £300,000 of key person insurance owned by her limited company. If Sarah dies, the company receives the payout to recruit a replacement and cover lost income.

The Critical Distinction: Key person insurance is owned by the business and pays the business. Personal life insurance is owned by you and pays your family or estate. You need both for complete protection.

Why Key Person Insurance Doesn't Replace Your Will

Key person insurance pays the business. Your will determines who inherits your business shares. These are completely separate.

What Insurance Does: Provides capital to survive your loss, covers recruitment, maintains cash flow.

What Insurance Doesn't Do: Provide for your family, transfer ownership, pay inheritance tax, or execute succession plans.

David, a self-employed plumber with £200,000 key person insurance, died without a will. The insurance paid his business account, but intestacy rules passed his business assets to his elderly parents instead of his partner who ran the business. The £200,000 sat frozen for 18 months. The business collapsed.

Emma owned 70% of a marketing agency with £400,000 insurance but no will. Her shares passed to her parents under intestacy. Without a shareholder agreement specifying sale terms, three years and £45,000 in legal fees were needed to resolve the dispute. Half the clients left.

Your insurance, shareholder agreement, and will must coordinate. Insurance provides capital. Agreements establish buy-sell terms. Your will transfers shares according to your wishes. Without integration, both family and business suffer.

How Your Business Structure Affects Your Will and Key Person Insurance

How key person insurance interacts with your estate depends entirely on your business structure. Each type requires different estate planning approach.

Sole Traders

As a sole trader, you and your business are legally the same entity. There's no separation between personal and business assets. When you die, the business ceases to exist unless your will explicitly transfers assets to someone who can continue.

Raj, a 52-year-old electrician, had £150,000 of key person insurance but no will addressing business assets. The insurance paid into his business account when he died. Under intestacy rules, his wife inherited everything—£35,000 in tools and equipment, an £18,000 van, and £65,000 in accounts receivable. However, she had no authority to collect payments from clients and no way to access the business bank account during probate. The insurance covered outstanding debts, but the real business value—client relationships, reputation, ongoing contracts—simply disappeared.

Sole traders need wills covering: Specific business asset transfer, clear accounts receivable collection authority, instructions for completing ongoing contracts, business name rights.

Partnerships

Your partnership share is a personal asset passing through your estate. Linda and Mark ran a 50-50 architectural partnership worth £500,000. Each had £250,000 of key person insurance and a documented buy-sell agreement. When Linda died at 58, Mark used the insurance payout to buy Linda's 50% share as their partnership agreement and Linda's will specified. Linda's family received £250,000 cash, Mark gained 100% control, and the business continued without disruption. This worked because all three elements—partnership agreement, insurance, and will—were perfectly coordinated.

Partners need wills covering: Partnership share transfer specifications, explicit reference to partnership agreement, contingency plans if buy-sell fails, dissolution instructions.

Limited Companies

With a limited company, you own shares in a separate legal entity. Your shares are part of your estate, but the business continues operating independently of your death. Kate, Tom, and Lisa owned a manufacturing company. Kate held 50%, Tom 30%, Lisa 20%. When Kate died at 53 without proper estate planning documentation, her 50% shareholding passed to her husband under intestacy rules. He knew nothing about manufacturing and clashed with Tom and Lisa. The company had £900,000 from Kate's insurance payout, but without a documented shareholder agreement or Kate's will authorizing a buyout, negotiations dragged on for 14 months and cost £250,000 in legal fees and business losses.

Company shareholders need wills covering: Precise share transfer instructions with company number and share class, explicit shareholder agreement reference, buy-sell authorization, valuation methodology, and appointment of business-savvy executors who understand commercial matters.

Shareholder Agreements and Buy-Sell Provisions: Why They Matter

A buy-sell provision (cross-option agreement) requires or permits surviving shareholders to purchase a deceased shareholder's shares at an agreed price, funded by insurance.

Three co-founders each owned 33.3% of a £900,000 company with £300,000 insurance in trust each. Their agreement specified a valuation formula. When Alex died, Ben and Cara received £300,000 from insurance and bought Alex's shares. Alex's widow received £310,000 cash within 90 days. Perfect execution.

Benefits: Your family gets guaranteed buyer, agreed valuation, quick payment. Your business maintains control, prevents disputes, ensures continuity.

Trust Structures: Insurance can be held in trust, with surviving shareholders owning policies on each other. Payout goes directly to survivors (avoiding corporation tax), who use it to buy deceased's shares.

Valuation Methods: Fixed amount, earnings multiple, professional valuation, book value, or hybrid. Your will and insurance must match the chosen method.

Tax Implications: Key Person Insurance, Inheritance Tax, and Corporation Tax

Premium Tax Treatment

Under HMRC BIM45525, premiums are tax-deductible if the sole purpose is covering lost trading income, the policy is term insurance with no investment element, and coverage matches the key person's usefulness.

Deductible: Term insurance covering lost revenue. Not deductible: Whole life policies with investment elements.

If premiums were deductible, payouts are taxable income (corporation tax applies). If not deductible, payouts are tax-free. At 25% corporation tax, a £300,000 payout leaves £225,000 net if premiums were deducted.

Inheritance Tax on Shares

Key person insurance payouts aren't part of your personal estate. However, your business shares are.

Business Property Relief (BPR) can provide 100% relief on qualifying trading company shares owned for two years. Marcus's £2 million company qualified for full BPR—his wife inherited with no inheritance tax.

BPR Reform from April 2026: £1 million allowance for 100% relief, then 50% relief above that. Unlisted shares reduced to 50% relief. Critical for businesses over £1 million.

Current inheritance tax threshold: £325,000, plus £175,000 residence band. Couples can pass up to £1 million tax-free. BPR can eliminate tax on business shares (until April 2026) or significantly reduce it afterward.

Using Trusts with Key Person Insurance: When and Why

Corporate Route: Company owns policy and receives payout. Simple, potentially tax-deductible premiums, but payout may face corporation tax.

Trust Route: Shareholders own policies on each other in trust. Payout goes directly to survivors (no corporation tax), faster access, cleaner for buy-sell. More complex and expensive to set up.

Three directors with £200,000 cross-policies in trust: When James died, Emma and Priya each received £200,000 from their policies on James. They used the £400,000 to buy his shares. No corporation tax, no company involvement.

Trust types: Bare (simple, fixed beneficiaries), Discretionary (flexible distribution), Split (hybrid).

Will coordination: Authorize share sales per agreement, name trustees, include contingencies. Don't contradict shareholder agreements.

Skip trusts if: Sole trader, sole shareholder, simple structure, or passing business to family. Company-owned insurance is simpler.

What to Include in Your Will as a Business Owner with Key Person Insurance

Essential Provisions:

  1. Specify exact shareholding: State company name, number, percentage of shares
  2. Reference shareholder agreement: Authorize executors to execute buy-sell terms
  3. Appoint business-savvy executors: Fellow director, accountant, commercial solicitor, or business-involved family
  4. Sole traders: Address asset transfer, accounts receivable authority, ongoing contracts
  5. Name guardians: For children under 18
  6. Clarify business debt payment: From business assets or general estate
  7. Include letter of wishes: Explain structure, insurance, succession preferences

Helen, 48, owns 60% of a recruitment agency. Her will states exact shareholding, directs executors to sell shares per the shareholder agreement dated 10 January 2022, appoints her spouse and co-director as executors, and includes contingency if buy-sell doesn't complete. Clear, comprehensive, coordinated.

Common Mistakes Business Owners Make with Key Person Insurance and Wills

1. Insurance but no will: Tom had £400,000 insurance but died intestate. Shares went to adult children who wanted nothing to do with business. Insurance sat frozen. Business collapsed within 18 months.

2. Agreement without funding: Co-founders had buy-sell agreement but no insurance. When one died, survivors couldn't fund £250,000 buyout. Business went into administration.

3. Wrong beneficiary: Sarah named husband on company-owned policy. £60,000 legal dispute followed about who owned the payout. Business relationship destroyed.

4. Outdated will: John's 2010 will reflected 50% of £200,000 business. By 2024: 75% of £1.8 million. Lengthy disputes with minority shareholders followed.

5. Assuming BPR guaranteed: Marcus's £2.5 million business held £800,000 investment properties. HMRC challenged BPR. Unexpected £380,000 tax bill.

6. Will contradicts agreement: Emma's agreement required share sale, will said "hold indefinitely." £85,000 in legal costs, 22 months litigation, business damaged.

7. No succession plan: David had £600,000 insurance but no successor. Nine months chaos, sold for 30% of value.

Solutions: Create coordinated will, fund agreements with insurance, match beneficiary designations to structure, review annually, get BPR advice, ensure consistency, document succession.

Creating a Coordinated Business Succession and Estate Plan

8-Step Action Plan:

  1. Assess position (Week 1): Document structure, ownership, insurance, agreements, will, valuation, tax situation
  2. Identify gaps (Week 2): Calculate insurance needs (3-5x profit contribution), business valuation, IHT liability, BPR eligibility
  3. Arrange insurance (Week 3-6): Work with broker to set up policies, choose corporate vs trust route, ensure correct beneficiaries
  4. Create shareholder agreement (Week 4-8): Draft buy-sell provisions, valuation method, payment terms with commercial solicitor
  5. Create/update will (Week 6-10): Specify ownership, reference agreement, appoint business-savvy executors, address debts
  6. Consider trusts (Week 8-12): If appropriate, establish trusts for insurance policies or share proceeds
  7. Review tax (Week 10-14): Confirm premium deductibility, assess BPR, plan for April 2026 reforms if over £1m value
  8. Document and communicate (Week 12-16): Create comprehensive succession plan, communicate to family and co-owners

Professional Help Needed: Insurance broker (commission-based), commercial solicitor (£2,000-£5,000), accountant (£1,000-£2,000). Total investment: £3,000-£7,000+.

Cost of No Plan: Business collapse (total loss), legal disputes (£40,000-£150,000), forced sale discount (30-50% value loss), inheritance tax (up to 40% if no BPR).

Frequently Asked Questions

Q: Does key person insurance pay out to my estate or my business?

A: Key person insurance pays out directly to your business, not your personal estate. The business owns the policy, pays the premiums, and receives the lump sum if you (the key person) die or become critically ill. This is a crucial distinction from personal life insurance, which typically benefits your family or estate.

Q: Do I need to mention key person insurance in my will?

A: You don't need to mention key person insurance in your will because the payout goes to the business, not your estate. However, you should mention your business shares in your will. If you're a sole trader, you'll need to address what happens to the business itself, as it's not a separate legal entity.

Q: Can I put key person insurance in a trust?

A: Yes, key person insurance can be placed in a trust, particularly for shareholder protection purposes. This arrangement allows the payout to go to surviving shareholders to buy your shares from your estate, avoiding probate delays and ensuring a smooth business transition. Trusts can also have inheritance tax advantages.

Q: What happens to key person insurance when a business owner dies without a will?

A: The key person insurance payout still goes to the business as planned, but your business shares (in a limited company) or business assets (for sole traders) will be distributed according to intestacy rules. This could mean your shares go to family members with no business experience, potentially destabilizing the company.

Q: Is key person insurance part of my estate for inheritance tax purposes?

A: No, key person insurance owned by and paid to the business is not part of your personal estate for inheritance tax purposes. However, your business shares are part of your estate. Business Property Relief may reduce or eliminate inheritance tax on qualifying business shares if owned for at least two years.

Q: Should my business have key person insurance if I have a shareholder agreement?

A: Absolutely. A shareholder agreement often includes "buy-sell" provisions requiring surviving shareholders to buy a deceased shareholder's shares. Key person insurance provides the funds to execute this agreement, preventing cash flow problems and ensuring your family receives fair value for your shares.

Q: How does key person insurance affect business succession planning?

A: Key person insurance provides emergency capital to keep the business running after your death while succession takes place. It covers recruitment costs, lost revenue, and operational expenses during the transition. This ensures your succession plan has time to work, whether that's family members taking over or the business being sold.

Conclusion

Key person insurance protects your business. Your will protects your family. A shareholder agreement protects both. These three elements must work together to create a complete succession and estate plan.

Key takeaways:

  • Key person insurance pays the business, not your estate—you still need a comprehensive will
  • Your business structure (sole trader, partnership, limited company) determines how insurance and your will interact
  • Shareholder agreements with buy-sell provisions should be funded with insurance to ensure smooth transitions
  • Tax treatment is complex—premiums may be deductible but payouts may be taxable
  • Business Property Relief can eliminate or reduce inheritance tax on business shares (subject to eligibility and upcoming reforms)
  • Trusts offer advantages for shareholder buy-sell arrangements but add complexity
  • Your will must explicitly address business interests and coordinate with shareholder agreements

James eventually got it right. After his accountant's wake-up call, James worked with a commercial solicitor to create a shareholder agreement funded with cross-option key person insurance. He created a comprehensive will authorizing the buy-sell arrangement and appointed his co-director as co-executor alongside his wife.

When James retired at 65, he knew his business was protected, his family would receive fair value for his shares, and his legacy was secure. That peace of mind was worth every penny of the planning investment.

Don't wait for a health scare or accountant's warning. If you own a business and have key person insurance, create a will that coordinates with your business protection strategy.

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Legal Disclaimer:

This article provides general information only and does not constitute legal or financial advice. WUHLD is not a law firm and does not provide legal advice. Laws and guidance change and their application depends on your circumstances. For advice about your situation, consult a qualified solicitor or regulated professional. Unless stated otherwise, information relates to England and Wales.

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