Life Insurance for Business Owners: What to Know

Quick Answer

Business owners may use life insurance to fund succession plans and to cover operating expenses during a transition to new leadership. Business life insurance may also provide replacement income for the owner’s family or resources to buy out the family’s interest in the business.

Small business owner standing in a coffee shop front door.

What would happen if you weren't there to run your business? Having funds in place to pay bills, continue operations and transition to new leadership could spell the difference between continuity and dissolution. Resources might also help your family make up for lost income or receive compensation for their interest in your company.

As a business owner, having a plan that includes life insurance can help you safeguard your family's future and the continuity of your business. How much life insurance do you need? Here's a quick primer on life insurance for business owners.

What Are Your Life Insurance Needs as a Business Owner?

As a business owner, you may want life insurance to help your partners, staff and family members or heirs deal with your business after you pass. This can mean different things in different circumstances. For starters, life insurance might cover key operating expenses, debt payments and the costs of finding a replacement to step in when you're gone.

These are some of the business expenses you may want to account for:

  • Rent or mortgage payments
  • Business loans
  • Outstanding invoices
  • Inventory
  • Payroll
  • Resources needed to complete projects
  • Recruitment and hiring costs for someone to step into your role
  • Lost revenue and production disruptions
  • Severance for employees if your business closes

Providing for Your Family

Additionally, you may want life insurance to provide for your family, instead of or in addition to any personal life insurance you may have. Here are two ways life insurance for your business might help your heirs.

  • Replacement income: Your insurance policy may provide replacement income for your family after your death. This could translate to five to 10 times your annual income, or it could be a lump sum based on needs.
  • Buy-sell agreements: Insurance may also offer funds for your partner(s) or company to buy out your family's interest in the business. Alternatively, insurance may pay your family so they can buy out your partners' share of the business, if that's your plan.

How to Calculate the Right Amount of Life Insurance Coverage

How much life insurance you need depends on what you want your insurance to cover. Because business owners can have complex needs, calculating the right amount of life insurance coverage can be complicated.

1. Start With a Plan

As a business owner, you need more than an insurance policy: You need a plan. Think through what would happen if you were to die. Who could take over in your absence? Who would want to do so? Would your family members like to continue in the business, or would they prefer to be bought out? If your business already has a partnership agreement that includes a succession plan, what is it? If there's no one to take over the business when you're gone, could your heirs sell your business or its assets—and, if so, what would it take to make the sale happen?

Knowing what is likely to happen helps you calculate what it might cost to carry out your plan. And because your plan will have ramifications beyond life insurance, take the time to discuss the possibilities with your associates and family members, so you have a clear idea of what everyone's preferences and expectations might be.

2. Calculate Expenses

Working with your accountant or a financial advisor, do a detailed analysis of your costs. How much would it take to keep your business up and running while it transitions to new leadership? What might it cost to recruit and hire a new executive? How much should you budget to make sure your clients aren't left in the lurch?

3. Get a Valuation

If your plan involves a buy-sell agreement or other transfer of ownership, you may need a business valuation so you know how much of a benefit you'll need. You may also want to have a new valuation done periodically so your insurance coverage can keep up with any increase in your company's value.

4. Protect Your Family

Considering your family's needs may require its own set of calculations. As a general rule, replacement income equals roughly five to 10 times your annual income. However, your family's needs might be greater, especially if you have young children who will have decades of care and college educations to pay for.

5. Ask the Experts

There are many moving parts to calculating how much business life insurance coverage you need. That's why consulting with a financial advisor can be critically helpful. Additionally, your business life insurance plan should include a legally binding agreement that spells out how the benefit money should be used. To that end, consulting with an attorney is also key.

Having a tax advisor review your plans and policy can help ensure you're not losing out on tax advantages—for example, by choosing the wrong beneficiaries. And finally, an experienced insurance agent can help walk you through your insurance options to make sure your coverage covers all the bases.

Types of Life Insurance to Consider

The primary types of life insurance for business owners to consider are term life insurance, permanent life insurance and key person coverage.

Term Life Insurance

Term life insurance offers coverage for a specific time period: one year, five years, 10 years or up to 30 years. If the insured person outlives the coverage period, there is no payout. You may be able to renew a policy at the end of the term, but your premium may go up.

Term life insurance often has lower monthly premiums than whole life insurance, and your premiums stay the same over the life of the policy. Term insurance may be faster and easier to get as well, and may not require a physical exam. However, one downside of term life insurance is that it doesn't accumulate any cash value. Its purpose is to pay a death benefit if you should die within the coverage period, without additional frills.

Permanent or Whole Life Insurance

Permanent life insurance (also known as whole life insurance or cash value insurance) takes a different approach to coverage and cash value. Like term life insurance, permanent life insurance pays a benefit when the insured person dies. However, permanent life insurance doesn't expire; it's meant to cover a person for their whole life, as long as the premiums are paid.

To make this possible, permanent insurance policies often have larger premiums. Any money not paid out in benefits over the years is invested to create a cash value. When the cash value reaches a certain level, you are entitled to access it, either as a withdrawal (with conditions) or a loan.

Which Type of Life Insurance Is Best for Your Business?

Choosing between whole life and term life insurance depends on a variety of factors. Here's a quick overview to help you sort out the differences.

  • Term life insurance offers immediate coverage and consistent premiums over a certain period of time.
  • Permanent life insurance provides whole life coverage but with higher premiums. A portion of your premiums will be invested and may be used as an asset. You may be able to increase your benefit or modify your premiums over time.
  • A combination of both types of insurance may work if you have multiple needs. For example, you might choose whole life insurance to fund a buy-sell agreement and use a separate term policy to provide key employee coverage with a payout to your family.
  • Some term policies are convertible to permanent insurance over time. Using a convertible policy, you may be able to extend coverage beyond the original term and possibly increase your coverage amount as well.

The Bottom Line

Making a plan to provide for your business and family after your death requires thought and discussion. Figuring out how much life insurance coverage you need to make your plan a reality is only slightly less complicated.

Get expert help to nail down expenses, iron out legal agreements and find the right insurance policy (or policies) to fit your needs. Though no one likes to think about what will happen when they're gone, it's worth building a careful plan that adequately protects your business and family without overdoing your coverage and cost.