Key person insurance, key man insurance is the older name, is a life or critical illness policy the corporation buys on someone the business cannot afford to lose. The corporation owns the policy, pays the premiums, and receives the benefit. The cash replaces lost profit, funds the search for a replacement, keeps lenders calm, and can fund a share buyout under a shareholders' agreement.
How the strategy works
We size the coverage from your statements, not a rule of thumb, using three checks: a multiple of the key person's compensation, the profit that would walk out the door with them and the years needed to rebuild it, and any buyout or lender requirements that set the number outright. Premiums are generally not deductible, with a narrow exception when a lender requires the policy as loan collateral. The death benefit arrives tax-free, and here is the part carrier pages skip: the benefit minus the policy's adjusted cost basis credits the Capital Dividend Account, so any portion the business does not need for continuity can later reach shareholders as a tax-free capital dividend. Because a serious illness is the likelier event during working years, many businesses pair the life coverage with corporate-owned critical illness insurance, sized separately.
This is likely relevant if
- Your business runs on one or two people, usually including you.
- A lender has asked, or will ask, what happens to repayment if a key person dies or gets seriously ill.
- A shareholders' agreement obliges the company to buy out a deceased owner's shares.
- Your top client relationships or production knowledge sit with someone who could not be replaced in under a year.
The wider corporate ownership picture is on corporate-owned life insurance in Canada, and our process shows how an engagement runs.
Talk to us before the bank asks
Doug Leyland and Jordan Matters are Chartered Professional Accountants, CPA, CA, and Private Client Estate and Succession Advisors. We size the coverage from your numbers, model the tax outcome including the CDA credit with your accountant, and say so plainly if no single absence would really move the numbers and the premium is better spent elsewhere.
Prefer to go deeper first? Request the full guide and we will send you our detailed briefing on this strategy.
Common questions
Are key person insurance premiums tax deductible in Canada?
Generally no. The corporation pays the premiums with after-tax dollars. A narrow exception can allow a portion of the premium to be deducted where a lender requires the policy and it is assigned as collateral for a loan. Because the conditions are specific, confirm the treatment with your accountant before relying on it.
How much key person insurance does a small business need?
Three methods give you the range. A multiple of the key person's salary is the quick estimate. Their contribution to profit, meaning the margin at risk and the years needed to rebuild it, is usually the more accurate one for an owner-managed business. Buyout obligations under a shareholders' agreement and lender requirements can set the number outright. A sound plan checks all three.
Does key person insurance cover illness or just death?
Both are available. Key person life insurance pays the corporation a tax-free death benefit at death. Key person critical illness insurance pays a lump sum while the person is alive, on diagnosis of a covered condition. During working years a serious illness is the likelier event, which is why many businesses carry both types.
Who receives the money from a key person policy?
The corporation. It owns the policy, pays the premiums, and is the beneficiary. Getting that structure right matters beyond the payout itself, because on a life policy the death benefit minus the policy's adjusted cost basis credits the company's Capital Dividend Account, which can later move surplus to shareholders tax-free.
