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Key Person Insurance

Also known as: Key Man Insurance, Key Employee Insurance

Definition

Key Person Insurance is a business-owned life insurance policy on a crucial employee, director, or owner that pays the company if that person dies or becomes critically ill.

Understanding key person insurance is essential for business owners planning comprehensive estate strategies, as it protects the value of your business—often your largest asset—for the beneficiaries named in your will.

What Does Key Person Insurance Mean?

Key person insurance (also called key man insurance) is business protection insurance where the company owns the policy, pays premiums, and receives payouts if a crucial employee dies or becomes critically ill. According to HMRC's Business Income Manual, employers may insure against loss of profits from losing a "key person." Any employee, director, or contractor critical to operations can qualify—not just shareholders. The business must demonstrate insurable interest by showing measurable financial loss if the person dies.

Payouts cover lost profits, recruitment costs, training expenses, or business continuity during transitions. Coverage typically ranges from £200,000 to over £1 million, calculated as 3-5 times salary or profit contribution. For example, a software company insuring its CTO for £500,000 uses the payout to hire interim technical leadership and recruit a permanent replacement when the CTO dies unexpectedly.

For estate planning, key person insurance provides liquidity for business succession plans outlined in your will. When Emma, a managing director, dies at 58, her £750,000 policy funds operational continuity while her daughter (named successor in Emma's will) transitions into leadership. This preserves business value for beneficiaries and prevents forced sale that would diminish the estate.

Tax treatment is complex: premiums may be tax-deductible if solely for trade purposes, using term insurance only, not extending beyond the person's usefulness. Policies for capital purposes like loan repayment or with investment features don't qualify. When premiums are deductible, payouts are typically taxable as trading income—consult an accountant.

Common Questions

"Does key person insurance only cover directors and shareholders?" No, it can cover any employee, director, or contractor critical to operations. You don't need to be a director or shareholder. The key factor is whether losing that person would cause significant financial loss. For example, a sales director generating 40% of revenue or a technical specialist with unique expertise could both be key persons.

"Are key person insurance premiums tax-deductible for my business?" Premiums may be tax-deductible if solely for trade purposes (covering loss of profits), using term insurance only, and not extending beyond the person's usefulness. Policies with investment content or serving capital purposes like loan repayment aren't deductible. When premiums are deductible, payouts are typically taxable as trading income. Consult an accountant for your specific situation.

"What's the difference between key person insurance and shareholder protection insurance?" Key person insurance pays the business to cover operational losses—lost revenue, recruitment costs, business continuity. Shareholder protection provides funds for remaining shareholders to buy out a deceased shareholder's shares. One protects operations, the other protects ownership. Many businesses need both.

Common Misconceptions

Myth: "Key person insurance is only for big companies, and the key person must be a director or major shareholder."

Reality: Key person insurance is crucial for businesses of all sizes. Any employee critical to operations can be covered—regardless of shareholding. Small businesses are often more vulnerable. A salesperson generating 60% of revenue or a technical specialist can be a key person. The determining factor is financial loss, not job title.

Myth: "Key person insurance premiums are always tax-deductible business expenses."

Reality: Premiums are only tax-deductible if the policy meets strict HMRC criteria: solely for trade purposes, term insurance with no investment content, and not extending beyond the person's usefulness. Policies for capital purposes like loan repayment or with whole life features aren't deductible. When premiums are deductible, payouts are typically taxable as trading income.

  • Business Succession Planning: Key person insurance provides financial foundation for succession plans in your will, ensuring smooth leadership transition.
  • Cross-Option Agreement: Often used together—key person insurance protects operations while cross-option agreements facilitate share transfers for ownership protection.
  • Life Insurance: Key person insurance is specialized life insurance with business ownership and unique tax treatment.
  • Estate: Protects estate value by preventing business failure after death, maintaining business value for beneficiaries.
  • Assets: Protects the business asset's value by ensuring continuity and preventing forced sale.

Need Help with Your Will?

Planning for your business after you're gone requires coordinating key person insurance with comprehensive will provisions. Understanding how business protection integrates with estate planning ensures your beneficiaries inherit the full value of your business assets.

Create your will with confidence using WUHLD's guided platform. For just £99.99, you'll get your complete, legally binding will plus three expert guides. Preview your will free before paying anything—no credit card required.

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.