Life insurance for small business owners: A complete guide

When you’re running a small business, you often don’t have time to think much further than your next move. Far-off needs, such as life insurance, may take a back seat.

But deciding what type of life insurance you need — and how much — doesn’t have to consume your day. What’s more, by considering your needs now, you can take important steps to protect your family’s income and preserve your business’s future. Life insurance for small business owners may feel complicated, but it can be simple and affordable. This guide walks you through the options, expected costs and the types of coverage that may suit you best.

Key takeaways

• For small business owners, life insurance must protect both their business and their family at the same time.

• Different business structures and needs can require different policy types; a sole proprietor will have different needs than the owner of a growing business with many employees.

• The tax treatment of your policy depends on several factors, including your business structure, the policyholder, and the beneficiary.

• You may be able to offer group life insurance as a tax-free benefit to your employees, even as a small business.

Why life insurance is different when you own the business

For most people, life insurance protects their family financially. The death benefit provides them with replacement income to help them continue to meet everyday expenses.

But for small business owners, the calculation is different. When you own the business, your death doesn’t just eliminate a paycheck; it can unravel the business itself. Partners, employees and vendors are all affected. Your personal assets may be tied up in the business. And unlike a salaried employee, you can’t simply sign on to the employer-provided group coverage plan — you are the employer, whether you’re a sole proprietor, part of a partnership or limited liability company (LLC), or founder of a growing S-Corp with staff.

For business owners, life insurance has to simultaneously protect both the family and the enterprise. Considering one without considering the other could leave a critical coverage gap. And if you’re worried about what could happen to your business when you’re gone, you’re not alone: According to research from PWC, 44% of US family firms cite succession planning as a key challenge.¹

How life insurance works for business owners: Core use cases

The kind of life insurance you need as a small business owner varies depending on what you’re trying to protect. Employees have one responsibility: protecting their family. But as a business owner, you may have three: protecting your family, your business, and (if you have them) your partners.

Each requires a different type of life insurance, with different benefit considerations and policy structures. As part of your business continuity and estate planning, you should carefully consider what needs a life insurance benefit will have to fulfill.

Protecting your family’s income

Without the income from your business, will your family be able to meet their expenses? Life insurance can help replace years of lost income, cover rent or mortgage payments, and provide an education to your dependents, among other things. If you’ve personally guaranteed any business debts, you’ll have to account for that amount in addition to whatever amount is needed to provide for your family.

Individual (i.e., owned and paid for by you) term life insurance and permanent (whole or universal) life insurance — with family members as the beneficiaries — can all be suitable ways to help replace the support they depend on. We’ll explain a bit more about how these types of policies differ below; however, you should consider working with a financial advisor to think about which kind of coverage — or combination of coverages — is best for your situation.

Protecting your business

As a small business owner, you’re the engine keeping your business moving forward. Whether it’s your unique skillset, your book of business, or your network of connections, if your business depends on you, you need to protect it.

With key person life insurance, the business holds the policy, pays the premiums, and is the beneficiary. Key person insurance pays a death benefit to the business after your death, which can be used as needed to help assure continued operations. For example, the payout could be used to train a new leader, pay off business debts, or cover lost revenue as the business transitions.

Protecting business partners or co-owners

If you own a business with someone else, what happens to your portion of the business after your death? Without a clear plan in place, your part of the business could be passed to your heirs, who may not want that responsibility — or have the capability to make the business work.

A buy-sell agreement establishes that plan ahead of time, stating who can buy a share of the business and at what price. This establishes a fair price for the business and ensures that your partner can purchase your share as agreed, rather than negotiating with your heirs.

For example, suppose you and your partner own a $2 million business, each with a 50% stake. Each of you takes out a $1 million life insurance policy on the other person. If you die, your partner (who is the beneficiary on that policy) receives the $1 million death benefit, which they use to buy your half of the company. Conversely, if they die first, you get your death benefit and purchase their half.

The sole proprietor: When you are the business

A sole proprietor is a self-employed business owner with no partners and no employees (or very few employees, none with significant roles). This basically means that you, and you alone, are the business, whether you’re a sole prop, a single-member LLC, or a one-owner S-Corp. That typically means that after your death, the business stops, and your family loses that income. They may not be able to extract any business equity, and outstanding business debts, if you had them, come due.

As a sole proprietor, your primary need for life insurance is to replace your income for your dependents, wind down the business, and repay any debts. You don’t need a buy-sell agreement or key person coverage when you don’t have business partners.

Term vs. permanent life insurance: Which makes sense for your situation?

As a small business owner, your insurance needs are more complex than those of the average person, and you should seriously consider discussing this issue with a financial advisor. They’ll likely tell you that term life insurance is initially more affordable than permanent whole life or universal life, but you have to remember that term coverage is temporary. And importantly, you can’t assume that you will be able to renew when the coverage expires.² A medical issue like a cancer diagnosis — even if completely curable — could make a new term policy prohibitively expensive.

That’s one reason why the added cost of permanent life insurance may be worth considering, especially if you need ongoing protection. Also, the cost impact is somewhat offset by the fact that whole and universal life policies build tax-advantaged cash value that can be accessed in numerous ways while you are still alive.

The cash value component of a whole life policy is often used to complement a small business owner’s retirement plan (such as a SEP-IRA, SIMPLE IRA, or a solo 401(k), or disability insurance policy, but it’s not designed to replace it.

Tax considerations: Can your business pay for your life insurance?

In some situations, your business may be able to pay the premiums for your life insurance. In other situations, you’ll pay them from your personal accounts. Whether the premiums are tax-deductible — and the death benefit taxable — depends on how the policy is structured, who pays for it, and who the beneficiary is.

• Sole proprietorship: If you purchase the policy personally, you’ll pay the premiums yourself and name your dependents as the beneficiaries. The premiums are typically not tax-deductible, but the death benefit is paid out free of income tax.

• Partnership: Either partner owns a policy, or the partnership itself owns the policies. The premiums are typically not tax-deductible, but the death benefit is often income tax-free. The IRS could treat partnership-paid premiums as taxable.

• LLC: The LLC can purchase and pay for key person insurance, but the premiums are typically not tax-deductible when the business is the beneficiary. A single-member LLC is usually taxed like a sole proprietorship, meaning premiums are treated as personal expenses and not tax-deductible. LLCs taxed as partnerships may treat premiums as compensation in some instances.

• S-Corp: Rules are strict for premium deductibility for S-Corps. If the business is the beneficiary, premiums are typically not deductible. If the policy is treated as compensation, the premiums may be deductible as a business expense. According to the IRS, the Section 79 rule for group coverage states an employer can provide up to $50,000 in life insurance as a tax-free perk.³

Consult a tax professional to see the tax implications of each policy type on your personal and business situation.

How to determine how much coverage you need

More than 70% of people overestimate the cost of life insurance.⁴ That means you can likely get the coverage you need at an affordable cost.

A healthy business owner, age 30, could buy up to $1 million of 20-year term life insurance coverage for an average cost of less than $50 per month, according to a Policygenius analysis of life insurance rates. A permanent, whole-life policy for the same person, would have an average monthly cost of $801 (female) and $920 (male) .⁵

Whole life insurance tends to cost more than term life because the coverage is permanent, not temporary, and a portion of your premium builds cash value over time. Cost is also affected by:

• Age

• Health

• Smoking/vaping status

• Policy type

• Coverage amount

• Riders, endorsements or additional coverages

Risk factors can increase your prices. Smokers pay more than double the rates that nonsmokers do, and high-risk hobbies, health conditions, and poor driving habits can raise your rates, too.

To decide how much coverage you need to protect your family financially, consider what your family would need to cover, such as:

• Your remaining mortgage balance

• Higher education needs for dependents

• Everyday living expenses

For business needs, there are other key variables to consider, such as:

• The amount of business revenue is dependent on you as the owner

• Outstanding debts that will need to be covered

• The costs of replacing yourself as a key person in the business

One way to start estimating your costs is to get an online insurance quote; however, before making any final decisions, it’s a good idea to discuss your broader financial goals with a qualified advisor.

Group life insurance: Offering coverage to your employees

A recent industry study found that more than half of employees (55%) believe life insurance is an important benefit, and nearly two-thirds of Gen Z workers (61%) want their employers to offer it.⁶ If your small business employs others, you may consider offering group life insurance. Group term life insurance is a single policy that can cover multiple employees as a tax-advantaged employee benefit.

With group life, the employer selects the plan, eligible employees can join, and the business pays part or all of the premium. Coverage amounts could be tied to a salary or offered as a flat amount (such as $30,000). Some plans also allow employees to purchase supplemental coverage, too.

Even employers with very small teams (2-5 employees) may be eligible for some group coverage if they meet participation and eligibility requirements, though price and availability vary.

Participation requirements usually state that 75% to 100% of employees must enroll, and the employer must pay a certain percentage of premiums. Life insurance up to $50,000 is typically tax-free to the employee, with amounts over that threshold treated as taxable income under IRC Section 79.

Taking the next step

As a business owner, choosing the right life insurance coverage is more than simply picking a benefit amount.

You’ll need to consider your specific business structure, family situation, and personal goals. You may need more than one policy to cover your needs.

If you have an insurance professional that you know and trust, ask them to help you map out the possibilities. If not, Guardian can connect you with a nearby financial advisor who can assess your business structure, coverage gaps, and budget to help identify the right type and level of coverage for you.

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