Life insurance for business owners: How much coverage do you need?

Small business owners take on a lot of risk — and, as a result, find themselves with a lot of insurance policies to juggle. Here what they need to know about life insurance.

Business owners need life insurance for all the same reasons that other people do. They should also have coverage designed to protect their businesses in the event they die unexpectedly. Because of this, business owners may need a larger death benefit and possibly more than one policy.

Life insurance for your family

The main reason people buy life insurance is to help survivors replace part of their income if they pass away. This is also a concern for business owners.

If you have a spouse, children, and/or other individuals who depend on your income, you should have life insurance. The policy death benefit can help survivors pay bills, cover debts, and pay for funeral expenses. It should be enough to replace your income for a set number of years.

If you don’t have dependents, you should consider the costs of paying for your funeral and settling your estate when determining your life insurance needs. You don’t want to pass those expenses on to parents or other surviving family members.

Life insurance for your business

Many business owners hope their companies can continue operating after their deaths. This is true in cases where a spouse or other family members are involved in the business. It is also common where the company employs several people who would lose their jobs if the business shuts down.

Life insurance is one way to help keep a company operating as it transitions beyond an owner’s death.

Life insurance can also help ensure the continuation of your business if you die. The policy’s death benefit can cover the expenses needed to recruit a professional to manage the business in your place. It can also provide the funds needed for the remaining partners to buy your share from your estate. And if the transfer of your business to heirs might incur an estate tax, a life insurance policy can help your heirs pay that bill.

The policy’s death benefit can also help pay off company debts and continue making payroll and covering other bills as the business transitions to new ownership.

There are a number of other circumstances in which business owners may need life insurance.

Collateral assignment of life insurance

If you have borrowed money to fund your business, your lender may require collateral assignment life insurance.

This arrangement helps ensure the lender gets repaid if you, the business owner, dies before the balance is paid in full.

You still name a primary beneficiary on the life insurance policy, such as your spouse. You also name the lender as the collateral assignee. That means the lender gets part of the policy death benefit if you die, enough to repay the loan in full. Your primary beneficiary receives the remainder.

For example, say you buy a $500,000 life insurance policy and name your spouse as primary beneficiary and your business lender as collateral assignee. You die still owing your lender $200,000. The lender will therefore receive $200,000 of the policy’s death benefit to repay the loan. Your spouse then gets the remaining $300,000 of the death benefit.

Combining life insurance with a buy-sell agreement

If you have one or more partners, your death could create uncertainty about the company’s future.

One way to mitigate this risk is for each owner to enter into a buy-sell agreement.

A common type of buy-sell agreement is one in which business owners agree that if one dies, the others are able to buy that owner’s shares in the business. A buy-sell agreement also allows for the purchasing of company shares from the estate of the surviving family.

To provide the funds needed to execute the buyout, each partner is covered by a life insurance policy naming the other partners as beneficiaries.

Key person life insurance

According to the National Association of Insurance Commissioners, 71 percent of firms surveyed said they were very dependent on one or two key people for their success. However, only 22 percent of respondents had key person life insurance in place.

Your company typically owns the key person life policy. The company also pays the premium and is the beneficiary.

In some circumstances, your business and a key employee may split the premium payments. This means you also split the policy benefits.

In either scenario, the employee must agree to the company’s purchase of key person insurance on their life.

Your company can use the death benefit for any number of purposes. These include finding a replacement, paying off debts, paying investors, or closing the business down in an orderly manner.

Learn More: Key Person Insurance

How to decide what coverage is best for you

For life insurance that is aimed at replacing income for your family, you can meet that need with term life insurance.

Term life insurance is a policy that guarantees payment of a stated death benefit if the covered person dies during a specified term. The most terms are 10 years, 20 years and 30 years.

Provided you pay the required premiums, the coverage will remain viable until the end of the term. If the term is 20 years, the policy will expire at the end of 20 years from the issue date.

The length of term will depend largely on how long you think your beneficiaries will depend on your income. The younger you are, the longer your term policy should cover.

For the various business arrangements that will potentially be funded by life insurance, you may have to use a whole life insurance policy.

Whole life insurance guarantees payment of a death benefit in exchange for level premium payments. Another way to define whole life insurance is that it’s a life insurance policy guaranteed to remain in force for the insured’s lifetime or to a maturity date, as long as required premiums are paid.

It is designed to provide coverage for the life of the insured. As long as the policy owner pays the required premium, the insured will always have life insurance coverage. Unlike term, there is no expiration on whole life insurance.

A whole life policy’s premium and death benefit typically remain the same for the life of the insurance contract.

Buying insurance for business owners is not a one-and-done transaction. As your business grows, your insurance needs will change as well. You should work with an independent insurance agent to help you assess your needs and re-assess them about once a year.


Joel Palmer is a freelance writer and personal finance expert who focuses on the mortgage, insurance, financial services, and technology industries. He spent the first 10 years of his career as a business and financial reporter.

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