Key Person Funding
Key person insurance protection involves the use of life insurance to create immediate working capital for a
business to meet immediate cash needs and to find a replacement in the event of the death of a business owner
or a key executive.
The business owner(s) and/or other key executives spend considerable time and effort in acquiring the knowledge,
experience, judgment, reputation, relationships and skills that make them valuable to the business. The death of
such an individual results in the loss of a key member of the management team and can have a severe financial
impact. During the resulting disruption, lenders may curtail credit, creditors may press for immediate payment,
debtors may delay making payments, employees and customers may lose confidence, and competitors may
take advantage of the situation.
Large corporations are often in a much better position to prepare for key executive turnover by sheer size and
numbers. Unfortunately, finding an immediate replacement with the same qualifications as a deceased owner or
executive is seldom possible in small business situations. It is often necessary to look outside of the business
to find a replacement, causing delays, disruption and reduced efficiency. The resulting effect on business profits
may further weaken the financial stability of the business. In the absence of proper planning, the very survival of
the business may thus be affected by the death of a business owner or a key executive.
A solution is for the business to purchase an insurance policy on the life of the business owner(s) and/or key
executives. In the event of death, the life insurance proceeds provide the business with needed working capital
to meet immediate cash needs and to provide a source of funds for finding, attracting, hiring, and training
a replacement for the deceased executive or, in the case of the death of a business owner, to hire interim
Life insurance premiums paid by the business for key person insurance protection are not deductible for tax
purposes. However, life insurance proceeds received as a consequence of death are tax-free. In the case of a
private corporation that receives life insurance proceeds as a consequence of death, the excess of the proceeds
over the adjusted cost basis of the policy credits (increases) the capital dividend account of the corporation.
Under subsection 83(2) of the Income Tax Act, R.S.C. 1985, c. I (5th Supp.) (ITA), the corporation can elect to
pay tax-free capital dividends to the shareholders of the corporation to the extent of any balance in the capital
Key person insurance protection provides many potential benefits to the business, the business owner and
the owner’s family. It helps to assure creditors and employees of the business that the business will continue
notwithstanding the death of the key person. The life insurance proceeds provide immediate cash at the time
of death to cover working capital needs of the business, and to find and train a suitable replacement for the
deceased. The value of these benefits to the business in the event of the death of the owner-manager or other
key executive will usually far exceed the cost of the life insurance.
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