What Is Key Person Insurance?

Key person insurance (also called key man insurance) is a life or critical illness insurance policy taken out by a business on the life of an employee or owner whose loss would significantly impact the company's ability to operate or generate revenue.

The business owns the policy, pays the premiums, and is the beneficiary. If the insured person passes away or suffers a critical illness, the company receives a tax-free lump sum payout to help stabilize operations, cover financial losses, or fund a replacement.

Why Do Canadian Business Owners Need Key Person Insurance?

Consider what happens when a key person is suddenly gone:

• Revenue drops because relationships, expertise, or skills walk out the door

• Lenders or investors may lose confidence in the business

• Recruiting and training a replacement costs time and money

• Business continuity is threatened during the transition period

Without key person coverage, many businesses are forced to draw down savings, take on debt, or in the worst case, shut down entirely. A well-structured key person policy provides the capital buffer to keep the business running.

How Does Key Person Insurance Work in Canada?

The corporation applies for a life insurance or critical illness policy on the key individual. The business pays the premiums from corporate dollars and is named as the beneficiary.

When a claim is made, the death benefit or critical illness payout goes directly to the corporation — tax-free in the case of a life insurance death benefit. This payout can be used for:

• Covering lost revenue during the transition period

• Funding the search and onboarding of a replacement

• Repaying business loans that required the key person as a guarantor

• Stabilizing operations and maintaining investor or lender confidence

• Contributing to the Capital Dividend Account (CDA) for tax-efficient shareholder distributions

Who Qualifies as a Key Person?

A key person is anyone whose loss would create a measurable financial impact on the business. Common examples include:

• Business founders or co-founders

• Top revenue-generating salespeople

• Technical experts with specialized knowledge

• C-suite executives (CEO, CFO, CTO)

• Professionals whose credentials are required for the business to operate

Key Person Insurance vs. Personal Life Insurance

Key person insurance is owned by the corporation, not the individual. This distinction matters for several reasons:

• Premiums are paid with corporate dollars — generally more tax-efficient than personal after-tax dollars

• The death benefit flows to the corporation, not the individual's estate

• The payout can flow through the Capital Dividend Account, allowing tax-free distributions to shareholders

Personal life insurance, by contrast, is designed to protect an individual's family — not the business itself.

Is Key Person Insurance Tax Deductible in Canada?

Generally, key person insurance premiums are not tax deductible in Canada. However, the death benefit is received tax-free by the corporation, and any amount above the policy's adjusted cost base (ACB) can be credited to the Capital Dividend Account — allowing shareholders to receive tax-free dividends.

This makes key person insurance a tax-efficient way to transfer wealth from the corporation to shareholders in the event of a loss.

How Much Coverage Does Your Business Need?

The right amount of coverage depends on several factors:

• The key person's contribution to annual revenue

• The cost of replacing them (recruitment, training, lost productivity)

• Outstanding business loans tied to the individual

• The time it would take to stabilize the business after their loss

A common approach is to insure for 3–5 times the key person's annual contribution to the business, though this varies based on your specific situation.