Life insurance for business owners: Should you have it?

Life insurance for business owners helps protect a company, its owners and their families if an owner or key employee dies. It’s commonly used to fund a buy-sell agreement, provide key person coverage or support broader succession planning. The right policy depends on your business structure, goals, cash flow, and who should own and benefit from the policy.

While personal life insurance provides financial security for your family, business owner life insurance helps protect the company itself.

“More often than not, people are the largest asset in a company,” says Jacob Kujala, senior product manager with U.S. Bancorp Advisors. “As a business owner, there’s an important financial dynamic to your value. Having life insurance makes a lot of business sense.”

Keep a few key considerations in mind as you select the best approach for your business.

What are the types of life insurance for business owners?

Business life insurance usually supports one of two strategies: buy-sell planning or key person protection. A buy-sell strategy uses life insurance proceeds to help surviving owners purchase a deceased owner’s share of the business. Key person coverage gives the business funds to absorb the financial impact of losing an essential owner or employee.

These aren’t separate insurance products. They’re planning strategies typically funded with traditional term or permanent life insurance policies.

What is buy-sell agreement life insurance?

Buy-sell agreement life insurance helps business owners plan for what happens if a co-owner dies. The proceeds can fund the purchase of the deceased owner's shares, helping surviving owners keep control of the business while providing liquidity to the deceased owner's family or estate.

A buy-sell agreement gives you that control. "A buy-sell agreement is beneficial if a business owner has a partner and would prefer not to work with the partner's family members if the partner passes away prematurely," says Tom Nicoski, senior vice president and product manager with U.S. Bancorp Advisors. "Life insurance proceeds can be used to purchase the business shares from the deceased partner's estate."

Business owners should also review entity-owned buy-sell arrangements in light of the Connelly v. U.S. decision, which may affect how life insurance proceeds influence business valuation for estate tax purposes.

In June 2024, the U.S. Supreme Court unanimously affirmed the 8th Circuit of Appeals ruling in Connelly v. U.S. The decision found that life insurance proceeds paid to a business inflate the fair market value of the company, and that the company's obligation to redeem shares from the deceased owner's estate doesn't reduce the business' value. For estate tax purposes, the deceased business owner's interest increases by the life insurance proceeds received by the business, in proportion to the owner's percentage ownership.

This ruling affects entity redemption strategies that business owners often use. In particular, it applies to company-owned life insurance, also called corporate-owned life insurance (COLI), where the company itself owns the policy and is the beneficiary. How many owners are involved, when they die and how their ownership percentages are structured all come into play. Business owners using these buy-sell strategies should work with their insurance and tax planning advisors to understand how the ruling affects their personal estate planning. 

“This is something that business owners will want to address sooner rather than later, and particularly if any buy-sell agreements were set up long ago and put in a drawer, so to speak,” Nicoski says. “Many business owners don't revisit those policies or the valuation of their business until something happens or until a professional asks them about it.”

Key person life insurance

Key person life insurance provides cash for the business if a key employee passes away. “The employee whose loss would materially affect revenue, operations or client relationships. If that person dies, the policy provides funds the business can use to stabilize operations, cover lost income, recruit a replacement or reassure lenders.

"The insurance proceeds provide a financial cushion while the business works through the loss of the individual's contributions to the business," Nicoski says.

While business owners often buy life insurance for buy-sell and key person reasons, Kujala notes that policies with those specific names don’t exist. “Key person and buy-sell agreements are risk mitigation and succession planning strategies that use traditional forms of life insurance,” he explains. “We’re often asked about the availability of buy-sell insurance, which is actually just life insurance used to fund the obligation on a buy-sell agreement.”

In many cases, companies will use term insurance, but sometimes permanent insurance (see the next section) makes the most sense. The key factors to consider include the purpose of the insurance and how it’s owned. As noted above, any company-owned life insurance may be affected by the Connelly vs. U.S. ruling.

Owners can buy a policy that funds a specific outcome they’re trying to achieve or potentially use one policy to fund multiple objectives. For example, a company may take out a policy that includes key person coverage for $1,000,000. Three quarters of that policy could offset the financial loss to the business if the employee passes away, while the remainder could go to the key person’s spouse as salary continuation.

Should business owners choose a term policy or permanent policy?

It depends on how you plan to use the policy. Term insurance is often used for lower-cost coverage during a defined period, such as early-stage buy-sell planning. Permanent insurance may suit long-term needs because it doesn't expire as long as premiums are maintained and it can build cash value.

The right choice depends on several factors, with the policy's intended use being the most important. Other factors include your business' cash flow, the total coverage you want and the age and health of the insureds.

Permanent insurance policies offer several benefits for long-term planning. “The business might use a permanent policy as a vehicle to grow cash value that can be used down the road as a bonus for a partner or for future projects,” Nicoski says.

Permanent policies also offer tax advantages. “Unlike other investments that can be owned by a business, life insurance enjoys tax-advantaged growth and distributions,” Kujala says. “Cash value that grows inside of a policy is tax deferred. When money is distributed from the policy, the policy owner can access the cost basis first and the gain afterward. And if they take the gain out as a loan, that is not taxable. If taking policy loans above cost basis, it’s important to monitor the policy against lapse to maintain the tax efficiencies.”

Term insurance, on the other hand, is often used for buy-sell arrangements in the early stages of a company’s life, Nicoski says. “Term policies are the least expensive way to insure an individual for a set period of time, allowing business owners to reinvest revenue back into the business during its growth years.”

Who should own a business life insurance policy?

Who should own a business life insurance policy depends on the policy’s purpose. For key person coverage, the business typically owns the policy, pays the premiums and is the beneficiary. For buy-sell planning, ownership may be structured as a cross-purchase agreement between individual owners, an entity-purchase arrangement owned by the business or a trust-owned structure.

“Without proper ownership and accounting, you can lose one of the biggest benefits for life insurance and the death benefit could become taxable. It’s important to get tax and legal professionals involved,” Kujala adds.

What else should business owners consider?

When evaluating life insurance for a business, review riders, beneficiaries, policy ownership, business valuation and the financial impact of losing a key person. No matter the size of your business, you can customize a policy to fit your needs.

What riders can a business life insurance policy include?

Optional riders can expand a policy’s usefulness. Common examples include long-term care access through accelerated death benefits and disability waiver of premium provisions that help keep coverage in force if the insured becomes disabled.

With the long-term care rider, you can use policy death benefits while living to help offset the cost of chronic care. With a disability waiver of premium, all or part of the policy’s costs can be waived to reduce expenses while keeping your coverage in place.

How should you choose beneficiaries?

Beneficiary designations should match the purpose of the policy and the ownership structure. Incorrect setup can reduce tax efficiency or create unintended consequences for the business and the insured’s estate.

How do you set the right buy-sell value?

For buy-sell planning, the face amount should align with a current business valuation. Because business value can change significantly over time, owners should review both valuation and coverage regularly.

“When you start your business, it may be worth a million dollars. Five years later, the business could be worth four million,” notes Nicoski. “You’ll want to get more coverage.”

How do you set the right key person value?

For key person coverage, the face amount should reflect the financial loss the business could experience, including lost revenue, transition costs and the time required to replace the individual.

Why does small business life insurance matter?

If you own a small business, comprehensive life insurance is especially critical. With a small team, you most likely play a pivotal role in daily operations and serve as the face of the business. Your unexpected death would challenge your family’s financial security and make it harder for your staff to take up the slack, putting their jobs and the business itself at risk.

Life insurance can help the business you worked so hard to build continue without you. You may need multiple policies based on ownership and beneficiaries, since you’ll want to account for both business expenses (payroll, outstanding loans, rent or mortgage payments, and the cost of replacing you) and your family’s income needs.

Frequently asked questions

What's the difference between key person insurance and a buy-sell agreement?

Key person insurance protects the business against the loss of an essential owner or employee, while a buy-sell agreement uses life insurance to fund the transfer of a deceased owner’s shares. Both strategies use traditional life insurance to fund different goals.

Can life insurance support business succession planning?

Yes. Life insurance can support business succession planning by providing funds for ownership transfer, protecting heirs and partners and helping the business continue operating after an owner exits or dies.

How much life insurance does a business owner need?

The amount depends on the policy’s purpose. For a buy-sell agreement, coverage should reflect a current business valuation. For key person insurance, it should reflect the financial impact of losing that individual and the cost and time required to replace them.

Is business life insurance tax deductible?

Premiums for business-owned life insurance generally aren't tax deductible. However, permanent policies offer tax-advantaged cash value growth, and death benefits are often received income tax free when ownership and beneficiary designations are structured correctly. Because tax treatment depends on your specific setup, work with a tax professional before you buy.

Can a business owner have both personal and business life insurance?

Yes, many business owners need both personal life insurance for family protection and business life insurance for succession planning, key person protection or debt coverage. The right mix depends on your ownership structure and beneficiary goals.

Life insurance for business owners: Finding the right support

Nicoski and Kujala agree that consulting a financial advisor can help you navigate the process.

“An advisor can open up different discussions and identify risks that the business owner might not have been thinking about,” says Kujala. “Trusted advisors, CPAs and attorneys can help strategize concepts that address those risks. The advisor is uniquely qualified to help the owner determine the policy type that best matches the strategy. They may also help the business owner find the premium dollars to fund their policies, too.”

Would your business benefit from life insurance? Learn about life insurance options from U.S. Bancorp Advisors.