Key-person insurance explained: how much cover, who owns the policy, and the tax treatment in seven countries
The calculation, the ownership choices, whether the premium is deductible and the payout taxed, and the clauses that matter.
General information, not advice.
What it covers, and what it does not
Key-person cover pays the business a lump sum on the death, and with the right policy the total and permanent disability or critical illness, of a named person. It does not pay the person's family (that is personal cover), does not buy their shares (that is buy-sell cover), and does not replace what they knew. Term cover to sixty-five or seventy is the usual form; the premium on US$2 million of ten-year term for a healthy forty-five-year-old is a few thousand dollars a year in every one of the seven markets.
How much?
Three methods, and the honest answer is the largest of them. Revenue: the profit attributable to the person for the years it would take to replace them, commonly two to three years. Replacement: the search, the premium hire, the first year's underperformance, together often a year's salary and a half. Debt: what a lender would call, or a guarantee the business could not meet. For a founder-led firm the number is commonly two to five times annual profit, or five to ten times the person's salary by the brokers' rule of thumb. Worked example: a consultancy with US$3 million of revenue and US$600,000 of profit, half of it from the founder's relationships; two years to replace her; a US$500,000 facility with a key-person covenant. Revenue method: US$600,000. Replacement: US$450,000. Debt: US$500,000. Cover: US$1.5 million, because the three losses arrive together.
Who owns the policy?
The company, usually: it pays and it receives. Where the purpose is to fund a share purchase, the shareholders or a trust own it instead. The choice decides the tax, so it is made with the accountant, not the broker, and it decides who the money is protected from: a company-owned payout is a company asset, reachable by the company's creditors and counted in the company's value.
Tax by country
Country | Premiums | Payout |
|---|---|---|
United States | Not deductible (section 264) | Income-tax free to the employer only if the insured was notified in writing and consented before the policy was issued and the section 101(j) conditions are met (the insured was an employee within the last year, or a director or highly compensated employee); otherwise the payout above premiums paid is taxable; Form 8925 filed annually |
United Kingdom | Deductible where the policy is for a revenue purpose (loss of profits), the term is short, and the person has no significant shareholding (the Anderson rules from 1944) | Taxable where the premiums were deductible; the two follow each other, so a policy for a capital purpose (repaying a loan, buying shares) is paid from taxed money and received tax-free |
Australia | Deductible for revenue purposes (replacing profit); not deductible for capital purposes (repaying debt, protecting goodwill); the purpose is set at the outset and recorded in a board minute | Assessable income for revenue purposes; a capital receipt for capital purposes, and exempt from capital gains tax for death and TPD proceeds paid to the original beneficial owner |
Canada | Not deductible, except the part of the premium a lender requires as collateral for a business loan (section 20(1)(e.2)) | Tax-free; the death benefit less the adjusted cost basis credits the private company's capital dividend account, from which it can be paid to shareholders tax-free |
Israel | Deductible as a business expense where the company is the beneficiary and the cover is for loss of income | Taxable income of the company where the premiums were deducted |
Singapore | Deductible where the company is the beneficiary, the policy is term cover with no surrender value, and the insured is a key employee whose loss would affect revenue | Taxable where the premiums were deducted; otherwise a capital receipt |
Germany, France, Spain | Deductible as a business expense where the company is the policyholder and beneficiary and the cover relates to the business (Germany treats cover on a shareholder-director's life for a capital purpose as non-deductible; France's assurance homme clé premiums are deductible) | Taxable income of the company; France allows the payout to be spread over five years for tax |
The clauses that matter
Definition of disability (own occupation or any occupation; the second pays far less often), the waiting period, whether the sum insured tracks the business's growth or is reviewed annually, conversion rights if the person leaves (the policy can often be assigned to them), the guaranteed renewability, and, in the United States, the consent notice without which the payout is taxed. The person insured should know the policy exists and what it is for; in every country a policy taken on someone's life without their knowledge is at best unenforceable and at worst unlawful.
Cover on the founder, cover on the rest
Founders insure themselves first and forget the people who actually run the place: the operations lead who knows every supplier, the developer who wrote the system, the salesperson with the three biggest accounts. The key-person list is the list of people whose absence for a year would cost more than their salary, and it is usually four or five names, not one.
The policy replaces the money
Nothing replaces the judgement, unless it was recorded while the person was here.
Insurers and advisers: Make an enquiry
Frequently asked
Is key-person insurance tax deductible?+
It depends on the country and the purpose: revenue-purpose cover is often deductible (UK, Australia, Singapore, most of the EU) and its payout taxed; capital-purpose cover is usually not deductible and its payout not taxed. The US does not allow the deduction and taxes the payout unless the consent rules were met; Canada allows neither the deduction nor the tax.
How much key-person cover does a small business need?+
The largest of: profit attributable to the person for the replacement period, the cost of replacing them, and the debt their loss would trigger; often two to five times annual profit.
Who receives the payout?+
The business, as owner and beneficiary; a buy-sell policy is structured so the family is paid for the shares instead.
Does the key person have to agree?+
Yes. In the United States written consent before issue is required for the payout to be tax-free; everywhere the insured must have consented for the policy to be valid.