Most businesses insure the shed, the ute and the stock. Far fewer insure the person the whole thing runs on. That is what key person insurance is for, and the decision that matters most is not how much cover you buy. It is who owns the policy.
Every small business has someone it cannot run without for long. On a family farm it is often the person who knows every paddock and every buyer. In a contracting business it is whoever holds the licence. Key person insurance puts money into the business if that person dies, becomes permanently disabled or is diagnosed with a serious illness. This is general information only, not personal financial advice, and not tax or legal advice.
Ironbark Wealth Advisers is a family-led firm based in Dubbo with over 35 years of experience, working with business owners across Dubbo, Orange and regional New South Wales. For the wider picture, start with our guide to how financial advisers help small business owners.
Quick summary
- Key person insurance is life, TPD or trauma cover written on an individual, arranged so the business receives the money.
- Key person insurance does not cover property, vehicles, stock or liability claims. That is general business insurance, and a different conversation.
- Cover is arranged for one of two purposes: replacing revenue the business loses, or providing capital to repay debt or buy out a share.
- Do not assume the premiums are deductible. The answer turns on why the policy was taken out.
- A buy sell agreement is a legal document drafted by a solicitor. Insurance is how that agreement gets funded.
What Key Person Insurance Is
Key person insurance is life, total and permanent disability or trauma cover taken out on a person whose death or serious illness would cost a business money, arranged so the proceeds reach the business. It pays when the insured person dies, becomes permanently disabled or is diagnosed with a listed condition, not when the business has a bad year. Key man insurance is the older name for the same thing, and the Australian Taxation Office still uses it.
The Three Covers a Key Person Insurance Policy Is Built From
A key person insurance policy uses the ordinary life, TPD and trauma covers, and what makes it key person cover is the reason it exists and where the money is directed. Life cover pays a lump sum on death. TPD cover pays where illness or injury leaves someone permanently unable to work. Trauma cover pays on diagnosis of a listed condition.
What Key Person Insurance Does Not Cover
Key person insurance does not cover buildings, plant, vehicles, stock, liability claims or a downturn in trade. Those sit with a general insurance broker. A business insurance schedule protects what the business owns; key person cover protects it against losing a person.
Who Counts as a Key Person in a Business
A key person is anyone whose absence would measurably reduce what the business earns or its ability to borrow. Job title is a poor guide. The test is what stops, and for how long, if that person is not there on Monday. In most small businesses it is the owner who holds the client relationships, the employee whose licence the business trades on, or whoever personally guaranteed the business debt.
Working Out How Much Key Person Cover to Take Out
The amount of key person cover is worked out from what the business would actually lose, not from a round number.
- The revenue genuinely attached to the key person. Start with income that would not continue, rather than total turnover. The period matters, because cover sized for six months and cover sized for three years are very different policies.
- Debt and personal guarantees. Add debt that would need repaying or refinancing, and ask the bank what it would do if a named guarantor were gone.
- Recruiting and training a replacement. In regional New South Wales that figure is usually larger than in a capital city, because the pool is smaller and roles take longer to fill.
Insurers apply financial underwriting, so a business seeking a large sum insured will be asked to demonstrate the loss with financial statements and an explanation of the person’s role. A figure chosen because it sounded about right tends not to survive that.
Who Owns the Key Person Insurance Policy, and Why That Decision Matters Most
Policy ownership decides who receives the money, when they receive it and how it is treated for tax, which is why it is settled before anyone discusses the sum insured. Getting the amount slightly wrong is recoverable. Getting the ownership wrong means the payout lands in the wrong hands at the worst possible moment.
The Two Purposes Key Person Cover Is Arranged For
Key person cover is arranged for one of two purposes: to replace revenue the business loses while it recovers, or to provide capital so the business can repay debt or buy out a departing owner’s share. Which one applies is settled first, because the purpose drives both the ownership and the tax treatment.
| Purpose | What the money is for | What the business is trying to avoid |
|---|---|---|
| Revenue | Replacing lost profit and covering wages, rent and loan repayments | Trading on the overdraft, or shedding staff it will need again |
| Capital | Repaying debt, releasing a personal guarantee, or funding the purchase of a share | A forced sale of assets, or surviving owners borrowing to buy the share |
A single policy asked to do both jobs tends to be sized for neither, so where a business needs both they are normally arranged as separate policies with each purpose documented at the outset.
How Policy Ownership Changes Where the Payout Lands
Where the business owns the policy the money arrives as a business asset and is available immediately, whereas where the individual owns it the money belongs to them or forms part of their estate. That second route is the one that catches people out, because moving the money into the business afterwards is not automatic. A separate trust can also own the policy, which is sometimes used in business succession planning where several owners insure each other.
The Tax Treatment of Key Person Insurance
The tax treatment of key person insurance depends on why the policy was taken out, not on how the payout is eventually spent.
The Revenue and Capital Distinction the ATO Applies
Where the purpose was to replace revenue, premiums may be deductible and proceeds may be assessable, and where the purpose was capital, such as funding a buyout or repaying a loan, the reverse tends to apply. The Australian Taxation Office’s long-standing ruling on key man insurance applies the High Court’s reasoning in Carapark Holdings, that insurance money is received on revenue account “where the purpose of the insurance was to fill the place of a revenue receipt which the event insured against has prevented”. The ATO looks at the circumstances when the policy was arranged, including company minutes and the reason for each renewal. Because the purpose is fixed at the start, deciding after a claim to spend the money differently does not change the treatment.
Why Key Person Insurance Tax Is a Question for Your Accountant
Your accountant decides how these arrangements are treated in your business’s return, because the answer depends on your structure and your documentation. The rules for business-purpose cover also differ from those for personal cover: the ATO is specific that an individual cannot claim a deduction for life insurance, trauma or critical care premiums on their own return. We work alongside your accountant on this, as part of how we approach tax planning.
Business Succession Planning and Buy Sell Agreements
A buy sell agreement is a legal contract between business owners setting out what happens to an owner’s share if they die, become permanently disabled or leave, and insurance is how that agreement is usually funded.
What a Buy Sell Agreement Does, and Who Drafts It
A buy sell agreement commits the remaining owners to buy, and the departing owner or their estate to sell, at a price or by a valuation method agreed in advance, and it is a legal document that a solicitor drafts. A financial adviser’s role sits alongside that: working out what the funding needs to be, arranging the cover, and making sure the insurance and the agreement describe the same events in the same terms.
What Happens to a Business Share With No Agreement in Place
With no agreement, a deceased owner’s share passes under their will, or under the intestacy rules if there is no will, which can leave the surviving owners in business with a family member who has no interest in running it. The share still carries its rights, and the surviving owners may have no right to buy it. A business succession arrangement and a will also have to describe the same outcome, because a will leaving a share to one person while an agreement commits it to another creates a dispute at the worst possible time, which makes it part of the same conversation as your estate planning.
Where Key Person Insurance Arrangements Go Wrong
Most key person insurance arrangements come undone on the wrong owner being named on the policy, cover that was never reviewed as the business grew, an agreement signed but never funded, or a tax treatment nobody confirmed with the accountant. None of them are about the premium.
- The wrong owner on the policy. The money arrives somewhere other than where it is needed and cannot simply be redirected. Easy to fix while everyone is well, effectively impossible at claim time.
- Cover never reviewed. A sum insured set when the business turned over half what it does now is no longer doing its job, and neither is a policy still naming an owner who left three years ago.
- An agreement signed but never funded. A buy sell agreement with no insurance behind it obliges the surviving owners to buy a share with money they may not have.
- A tax treatment nobody checked. The surprise then arrives in the year the business can least afford it.
How Ironbark Works Through Key Person Insurance and Business Succession
Ironbark follows the same five step advice process for every client, and a key person insurance question runs through all of it.
- Discovery. A conversation about your goals, financial position, lifestyle needs and future aspirations, which for a business owner includes who the business genuinely depends on.
- Analysis and Research. Detailed analysis, using trusted research partners to review your options, including what the business would actually lose.
- Strategy and Recommendations. A tailored plan reflecting your goals, risk comfort and long term priorities, covering the amount, the structure and the ownership.
- Implementation. We handle setup, applications, underwriting and paperwork, working with your accountant or solicitor where needed, which here is almost always.
- Ongoing Support. Your adviser stays with you, reviewing and adjusting as the business and the rules change, and assisting at claim time.
For key person cover, the weight sits in steps three and four, because the structure and the coordination with your accountant and solicitor are what make the arrangement work. There is more on how we work with clients at every stage.
Frequently Asked Questions
What is key person insurance?
Key person insurance is life, total and permanent disability or trauma cover taken out on a person whose death or serious illness would cost a business money, arranged so the proceeds reach the business. It insures the person, not the premises or the stock.
Can the key person be the beneficiary?
The key person can be the beneficiary, but it changes what the arrangement does. Where the insured individual owns the policy, the money goes to them or their estate rather than to the business, and moving it into the business afterwards is not automatic. Where the purpose is to protect the business, the policy is usually owned so the proceeds arrive there. It is a structuring decision to make before the cover starts.
Is key person insurance tax deductible?
It depends on why the policy was taken out, and there is no general answer. The Australian Taxation Office distinguishes between cover arranged for a revenue purpose, such as replacing lost profit, and cover arranged for a capital purpose, such as repaying a loan or funding a buyout. It looks at the purpose when the policy was arranged, not at how the money is spent. Your accountant should confirm the treatment for your business.
What is the difference between key person insurance and a buy sell agreement?
Key person insurance and a buy sell agreement do different jobs and are usually used together. A buy sell agreement is a legal contract, drafted by a solicitor, setting out who buys an owner’s share and on what terms if that owner dies, becomes disabled or leaves. Key person insurance provides the money. An agreement without funding is a promise, and funding without an agreement leaves the terms of the sale unsettled.
Does a small business need key person insurance?
Not every small business needs key person insurance. The question is whether the business would lose measurable revenue, or face a debt falling due, if one particular person were suddenly not there. A business with several interchangeable people and no borrowings may not need it. A business built on one owner’s licence, relationships or personal guarantee usually has more exposure than it realises.
Talk to Ironbark About Key Person Insurance
Key person insurance is straightforward to set up properly and very difficult to fix afterwards. The useful questions are who the business depends on, what it would lose, and who should own the policy.
There is no pressure and no obligation. You are welcome to call us on (02) 6884 4680, send us an online enquiry, or book a consultation at a time that suits you. Visit our Church Street office in Dubbo, have us come to you across Orange and the Central West, or meet online. You can also read about our insurance advice, how we support business owners, or explore the Ironbark Knowledge Hub.
This article was written by the team at Ironbark Wealth Advisers, a family-led financial planning firm with over 35 years of experience, supporting families and business owners across Dubbo, Orange and regional New South Wales. Ironbark Wealth Advisers Pty Ltd is a Corporate Authorised Representative (CAR No. 315227) of Madison Financial Group Pty Ltd, AFSL No. 246679. This article is general information only and does not take into account your objectives, financial situation or needs. It is not tax or legal advice. Please consider the relevant Financial Services Guide (FSG) and Product Disclosure Statement (PDS), and speak with your accountant and solicitor, before making any decisions.
References
- Australian Taxation Office, IT 155 Key man insurance, assessability of proceeds and deductibility of premiums, https://www.ato.gov.au/law/view/pdf/pbr/it0155.pdf
- Australian Taxation Office, Income protection insurance (deductions for insurance premiums), https://www.ato.gov.au/individuals-and-families/income-deductions-offsets-and-records/deductions-you-can-claim/investments-insurance-and-super/income-protection-insurance
- ASIC Moneysmart, Life insurance cover, https://moneysmart.gov.au/how-life-insurance-works/life-insurance-cover
- ASIC Moneysmart, Total and permanent disability (TPD) insurance, https://moneysmart.gov.au/how-life-insurance-works/total-and-permanent-disability-tpd-insurance
- ASIC Moneysmart, Trauma insurance, https://moneysmart.gov.au/how-life-insurance-works/trauma-insurance
