Business Planning Guide
Key Person Insurance: How It Works, Who Owns the Policy, and How It Fits a Business Continuity Plan
Most businesses depend on a few people. Some bring in the clients, some hold the technical knowledge, and some keep the lenders comfortable. Key person insurance is one way a company can plan for losing one of those people, and it works best when it is part of a coordinated plan rather than a policy bought on its own.
Definition
What Is Key Person Insurance?
Key person insurance is a life insurance policy that a business buys on an owner or employee whose loss could cause it serious financial harm. The business owns the policy, pays the premiums and is the beneficiary. If the insured dies, the death benefit goes to the company. It can then use the money to cover lost revenue, recruit a replacement, reassure lenders or keep operating through the transition.
You may also see it called key man insurance, key employee life insurance or key person life insurance. Those names all describe the same arrangement. It protects the business. It does not replace income for the insured person's family, and it does not buy anyone's ownership shares.
Who Is Often Considered a Key Person
- 1A founder or owner whose relationships drive most of the revenue
- 2A technical lead, physician, engineer or creative director with knowledge that is hard to replace
- 3An executive who personally guarantees business loans or credit lines
- 4A sales leader whose departure could affect major client accounts
Key Federal Reference Points
The Rules Behind Employer-Owned Policies
8/17/2006
According to the IRS, Form 8925 generally applies to employer-owned contracts issued after this date
1 Year
Written consent is generally valid only if the policy is issued within one year, or before employment ends if that comes first
Every Year
Form 8925 is generally filed for each tax year the business owns the contract
Sources: IRS, About Form 8925 and Form 8925 and instructions (Rev. Sept. 2017), checked November 10, 2026.
The Mechanics
How Key Person Insurance Works, Step by Step
Each of the steps below needs the right paperwork. If the order is wrong or a step is missed, the death benefit may become taxable.
Identify Who the Business Depends On
Leadership looks at revenue, client relationships, loan guarantees and specialized knowledge to find the people the business would have the most trouble losing.
Estimate the Financial Impact
Common ways to estimate it include the person's contribution to profit, the cost of recruiting and training a replacement, any debt that might be called, and the cash needed to get through the transition. The right amount depends on your situation, and insurers also apply their own underwriting limits.
Complete Notice and Consent Before the Policy Is Issued
The employee receives written notice and signs written consent before the policy is issued. This step comes from IRC §101(j), which is covered below.
The Business Owns, Pays and Receives
The company is the owner and beneficiary of the policy and pays the premiums from business funds. If the insured dies, the company receives the death benefit and uses it as its continuity plan directs.
Report and Review Each Year
Your CPA files Form 8925 when required. Your team should also check each year that the coverage still fits the person's role and what the business is worth.
Side-by-Side
Key Person Coverage vs Buy-Sell Funding vs Personal Life Insurance
These three uses of life insurance are easy to mix up because the same person may be insured under all of them. What sets them apart is who owns each policy, who gets paid and what the money is for.
| Feature | Key Person Coverage | Buy-Sell Funding | Personal Life Insurance |
|---|---|---|---|
| Policy owner | The business | The business (entity redemption) or the co-owners (cross-purchase) | The individual, a spouse or a trust |
| Beneficiary | The business | Whoever is obligated to buy the deceased owner's shares | Family members, a trust or charities |
| Primary purpose | Offset the company's financial loss and support operations | Provide money to buy the deceased owner's interest | Replace income and support personal estate goals |
| Who pays premiums | The business | The business or the individual owners, depending on structure | The individual or trust |
| Governing document | Board or owner resolution plus §101(j) consent | The buy-sell agreement | Estate plan and beneficiary designations |
Many owners need more than one of these, and each serves a different purpose. To see how the pieces fit, read our guide to business succession planning in Denver.
Tax Rules
IRC §101(j), Form 8925 and How Key Person Insurance Is Taxed
The Notice-and-Consent Requirement
Under IRC §101(j), life insurance a business owns on an employee is generally treated as employer-owned. Unless an exception applies, the amount of the death benefit the business can exclude from income is limited to the premiums and other amounts it paid. The exceptions cover certain insureds, such as people who were employees in the 12 months before death or who met specified status tests when the policy was issued. They apply only if notice and consent were completed first. Before the policy is issued, the employee must:
- Get written notice that the employer intends to insure them, including the maximum face amount
- Give written consent to being insured, including coverage that may continue after they leave the job
- Get written notice that the employer will be a beneficiary of the death proceeds
The IRS has also issued question-and-answer guidance on employer-owned contracts in Notice 2009-48.
Annual Reporting on Form 8925
According to the IRS, a policyholder that owns employer-owned life insurance contracts issued after August 17, 2006, generally must file Form 8925 with its income tax return for each year it owns them. The form reports the number of employees, the number of insured employees, the amount of insurance in force and whether valid consent was obtained. The reporting requirement comes from IRC §6039I.
Premiums Are Generally Not Deductible
IRC §264(a)(1) generally does not allow a deduction for life insurance premiums when the taxpayer is directly or indirectly a beneficiary. Because the business is the beneficiary of a key person policy, its premiums are generally not deductible. In return, the death benefit may be received income-tax-free if §101(j) is satisfied.
Confirm with your CPA. How these rules apply depends on your entity type, the ownership structure and the facts at the time the policy is issued. Other rules may also apply, such as how proceeds affect the value of your business. The Stellarix Group coordinates with your CPA and attorney and does not give tax or legal advice. Sources were checked November 10, 2026.
Already own a policy on an employee?
We can look at your ownership, beneficiary and consent records with you and flag questions for your CPA before year-end filings.
Beyond Life Insurance
Key Person Disability Coverage
A key person who can't work because of illness or injury can strain a business as much as one who dies, and sometimes for longer. Key person disability coverage is generally designed to pay the business a benefit while an insured key employee is disabled. The business can use it for expenses, temporary help or lost revenue.
These policies usually have a waiting period before benefits start and a limited benefit period. The definitions of disability also vary. This coverage is separate from disability buy-out coverage, which is meant to fund the purchase of a disabled owner's shares under a buy-sell agreement. Tax treatment of premiums and benefits depends on how the policy is set up, so review it with your CPA.
Questions to Ask Before You Buy
- How long could the business run without this person?
- Does the policy's definition of disability match what the person actually does?
- Does your buy-sell agreement say what happens if an owner becomes disabled?
- Does the insured already have personal disability coverage?
Continuity Planning
How Key Person Insurance Fits a Business Continuity Plan
Key person insurance is one point of light in a larger constellation. A death benefit provides cash, but someone still has to decide in advance who leads, who calls clients and how the money is used. Insurance can help with the financial side of a loss. It cannot replace the person, and it is unlikely to cover every cost.
Get a Key Person Coverage Review
A conversation with our insurance planning team about who your business depends on, what coverage you already have and the questions to bring to your CPA.
Avoid These Missteps
Common Key Person Insurance Mistakes
Skipping Consent Paperwork
If consent is signed after the policy is issued, or never signed, the death benefit may become partly taxable.
Using One Policy for Every Purpose
Counting a key person policy as buy-sell funding without documenting it can lead to disputes between the business and the owner's family.
Setting and Forgetting
Roles, revenue and ownership change over time. If coverage isn't reviewed, it may end up insuring the wrong people or the wrong amounts.
Our Approach
How The Stellarix Group Helps Business Owners
We include key person coverage in our broader risk management and insurance planning, so it works alongside your buy-sell agreement, succession plan, investments and family's estate plan. We work with your CPA and attorney on tax and legal documents. We serve business owners from our Denver office and in all 50 states, and much of that work happens virtually.
Insurance and advisory services are offered through MML Investors Services, LLC, a MassMutual affiliate. We may receive commissions on insurance, which creates a conflict of interest. We explain how we are paid and talk through those conflicts before making any recommendation. To learn more about working with us, visit our page for business owners in Denver.
Insurance planning team: Melissa Lang, CLU, ChSNC, CLTC; Tom Mueller, ChFC; Bruce Lutz, LUTCF · Financial Advisors, The Stellarix Group
FAQ
Key Person Insurance Questions
What Is Key Employee Life Insurance?
Key employee life insurance is another name for key person insurance. It is a life insurance policy that a business owns on an important employee or owner, pays the premiums for and is the beneficiary of. Its purpose is to help the business manage the financial impact if that person dies.
What Is the Purpose of Key Person Insurance?
Key person insurance gives a business money if it loses someone critical to its operations. The business can use that money for lost revenue, hiring costs, debt obligations or the transition to new leadership. It does not replace the person's knowledge or relationships.
Is Key Person Insurance Worth It?
Whether key person insurance makes sense depends on how much the business relies on one person, how it would pay for a disruption and how the premiums compare with other priorities. Some companies keep cash reserves or spread responsibilities across more people instead. Looking at the financial impact usually comes before any decision about coverage.
How Much Does Key Person Life Insurance Cost?
The cost of key person life insurance depends on the insured's age, health, coverage amount, policy type and underwriting results, so no single price applies. Premiums are generally paid with after-tax business funds because they are generally not deductible. Your actual cost is set only after underwriting.
Are Key Person Insurance Premiums Tax Deductible?
Key person insurance premiums are generally not deductible. Under IRC §264(a)(1), a business generally cannot deduct premiums on a policy where it is directly or indirectly a beneficiary. Confirm how this applies to your business with your CPA.
What Happens to the Policy If the Key Person Leaves?
When a key person leaves, the business still owns the policy and can usually keep it, surrender it or, in some cases, transfer it. That includes transferring it to the departing employee. Each choice has its own tax and contract consequences, so review the options with your advisor and CPA before acting.
One Star to Guide the Way
Plan for the People Your Business Depends On
Our team can help you work out who is essential to your business, what losing them could cost, and how key person coverage might fit with your buy-sell agreement and succession plan. Coverage amounts and suitability depend on your situation.
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