Operating or holding company
Which company owns the policy affects creditor exposure and, on a sale, whether shares qualify for the lifetime capital gains exemption. A death benefit received by an operating company may be exposed to its creditors.
Key Person Insurance
Key Person Insurance for Ontario Businesses
Life insurance your corporation owns on someone the business depends on. If that person dies, the money goes to the business, to help cover lost revenue, repay debt and find a replacement.
What It Is
What is key person insurance?
Key person insurance is life insurance a business owns on an owner or employee whose loss would hurt it financially. The business pays the premiums and receives the death benefit, so the money arrives where the damage is felt.
A key person is anyone the numbers depend on: an owner, a senior manager, a top salesperson or someone with specialized technical skills.
If that person dies, lenders may call loans, suppliers may tighten credit and customers may leave. The death benefit can fund working capital, repay loans, and recruit and train a replacement.
At a glance
- Owned by the businessThe corporation is policyholder and beneficiary
- The person insuredTakes part in the application and underwriting
- Premiums generally not deductibleWith a limited exception for loan collateral
- Death benefit generally tax-freeTo the corporation, under an exempt policy
- Capital Dividend Account creditDeath benefit minus the policy's adjusted cost base
Ownership
Who owns the policy and who pays?
Usually the corporation owns the policy, pays the premiums and is the beneficiary. The money stays in the business that suffered the loss, and the premiums generally aren't a taxable benefit to the person insured.
Naming a personal beneficiary
If the corporation pays but a family member receives the benefit, it can trigger tax or a shareholder benefit. Keep the beneficiary in line with the business purpose.
Term or permanent
Term coverage suits a need with an end date, such as a loan or the years until someone retires. Permanent coverage suits a need that lasts, and can build cash value.
Sizing the Coverage
How much key person insurance does a business need?
No rule sets the amount. It's usually reasoned from what the person's loss would cost the business, then tested against what an insurer will underwrite.
Multiple of compensation
A quick starting point. Insurers set their own limits, and one published guideline usually considers five times income, with up to ten in strong cases.
Lost profit
Estimate how long it would take to recruit and train a replacement, and what share of sales or profit the person drives over that period.
Replacement and credit
Add recruiting and training costs, extra salary during the transition, and any loans or credit lines the business could lose.
Show your reasoning
Insurers generally want the reasoning on file: why this person is key, and what the business stands to lose. Review the amount when the person's role, the debt or the company's profits change.
Tax Treatment
Are premiums deductible, and is the death benefit taxed?
Generally, premiums are not deductible and the death benefit is not taxable to the corporation. The details below are why your accountant should confirm the treatment.
| Item | General treatment | Watch for |
|---|---|---|
| Premiums | Generally not deductible | A limited deduction may apply if a bank or similar lender requires the policy as collateral for a loan with deductible interest |
| Death benefit | Generally not taxable under an exempt policy | May be exposed to the corporation's creditors |
| CDA credit | Death benefit minus the policy's adjusted cost base, for a private corporation | A high adjusted cost base early in a policy's life can reduce the credit |
| Surrender | Proceeds above the adjusted cost base are generally taxable income | Amounts included in income can count as passive income for the small business limit |
| Moving the policy out | Can trigger tax or a shareholder benefit | Review before transferring it to a person or another company |
The Capital Dividend Account
How does the CDA relate to key person insurance?
When a private corporation receives a death benefit, the amount above the policy's adjusted cost base is credited to its Capital Dividend Account. With a proper election, it can be paid to Canadian-resident shareholders as tax-free capital dividends.
The credit and the cash are separate. A business recovering from a loss may need the cash for payroll, debt and hiring, so it may not pay capital dividends right away. Later capital losses can reduce the balance, so timing is worth discussing with your accountant.
Capital dividends go to shareholders, not to the key person's family. Any support for a non-shareholder's family is a separate decision with its own tax treatment.
Who It Fits
Who is key person insurance for?
- One or two people drive revenueClients, contracts or skills follow them
- Bank debt or personal guaranteesLenders may react to the loss
- A small teamNo one ready to step in quickly
- Cash flow to carry premiumsFor as long as the need lasts
What to Weigh First
When it may not fit
It doesn't fund a buyout
Key person coverage replaces what the business loses. Buying a deceased owner's shares is a separate job for buy-sell insurance.
The need may end
If the person leaves or retires, the corporation has to decide what to do with the policy.
Underwriting decides
Age and health set the cost, and coverage isn't always available.
How We Work With Your Accountant
Your accountant leads the tax side
We size it
We work through what the person's loss could cost, and quote coverage to match.
Your accountant reviews
They confirm ownership, the beneficiary and the CDA treatment.
We implement
We handle the insurer, underwriting and paperwork.
Common Questions
Questions owners ask about key person insurance
In most cases, no. A limited part of the premium may be deductible if a bank or similar lender requires the policy as collateral for a business loan and other conditions are met. Your accountant confirms the treatment.
Generally not, under an exempt life insurance policy. For a private corporation, the amount above the policy's adjusted cost base is also credited to its Capital Dividend Account.
In practice, yes, because they take part in the application and underwriting. Under Ontario's Insurance Act, a corporation has an insurable interest in its directors, officers and employees. Without one, a contract is void unless the person insured consented in writing.
The corporation owns the policy, so it decides whether to keep, cancel or transfer it. Transferring it out can trigger tax or a shareholder benefit, so speak to your accountant first.
It's usually clearer to size them separately. The same dollars can't both replace lost revenue and buy out a deceased owner's shares.
A life policy pays at death. Critical illness coverage can be set up as key person coverage, with the corporation owning the policy and receiving the benefit. The tax treatment differs, so your accountant should review it.
Related Guides
Strategies that often work together
Buy-Sell Insurance
Funding a shareholder agreement with life insurance, and the structures to compare.
Read the guideCorporate-Owned Life Insurance
Permanent coverage owned by the corporation, with tax-sheltered growth and CDA planning.
Read the guideCapital Dividend Account (CDA)
How the CDA lets certain amounts leave a private corporation as tax-free capital dividends.
Read the guideThis information is general in nature and is not tax, legal, accounting, insurance or investment advice. It is based on current Canadian tax legislation, which can change. Any strategy should be designed and reviewed with your accountant and legal advisors based on your circumstances. Values above the policy guarantees, including dividends, are not guaranteed.
Key person insurance in Burlington, Oakville, Milton, Mississauga and Hamilton
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What would losing a key person cost your business?
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