Key Person Insurance -- Tax Treatment UK 2026

What Is Key Person Insurance?

Key person insurance -- sometimes called keyman insurance -- is a life or critical illness policy that a business takes out on an individual whose skills, relationships, or knowledge are so central to operations that their death or serious illness would cause significant financial harm to the company.

The business pays the premiums, owns the policy, and receives the payout. That payout is then used to keep the business running while a replacement is found, to service debts that the key person guaranteed, or to compensate for lost profits during the period of disruption.

Key person insurance is distinct from shareholder protection (which funds a buyout of shares from a deceased owner's estate) and from a relevant life policy (which provides death-in-service cover paid to the employee's family rather than the business).

Who Qualifies as a Key Person?

A key person is any individual whose absence would materially harm the business. Common examples include:

• A sole director whose personal relationships drive the bulk of client revenue
• A lead software developer who holds critical technical knowledge not documented elsewhere
• A sales director responsible for a disproportionate share of turnover
• A managing director who is the named guarantor on business loans

There is no statutory definition. HMRC focuses on whether the financial loss to the business is real and quantifiable, and whether the policy is genuinely designed to indemnify that loss.

How to Calculate the Sum Assured

Getting the sum assured right matters because underinsurance leaves a coverage gap while overinsurance can prompt HMRC to challenge the deductibility of premiums. Three calculation methods are commonly used together.

Method 1 -- Profit Multiple

Estimate the key person's personal contribution to gross profit, then multiply by the number of years it would take to replace them and restore earnings to their previous level. Typical multipliers range from two to five years.

Example: A sales director generates GBP 180,000 of gross profit annually. The business estimates it would take three years to reach that level again with a new hire. Sum assured = GBP 180,000 x 3 = GBP 540,000.

Method 2 -- Debt Cover

If the key person has personally guaranteed any business borrowing, include the outstanding balance. A lender may call in a guarantee on death or incapacity.

Example: The same director has guaranteed a GBP 150,000 business loan. Adding debt cover: GBP 540,000 + GBP 150,000 = GBP 690,000.

Method 3 -- Replacement Cost

Estimate the total cost of recruiting, relocating, and training a suitable replacement, plus the cost of interim cover such as a temporary director or consultant.

Example: Headhunter fees of GBP 40,000, relocation package of GBP 15,000, and GBP 25,000 for a six-month interim. Adding GBP 80,000 gives a total indicative sum assured of GBP 770,000.

Many policies are written in layers -- term life for the full amount and critical illness cover at a lower sum -- to keep premiums manageable while covering the most likely risks.

Term Life vs Critical Illness Cover

Term life pays out on death during the policy term. Critical illness pays out on diagnosis of a specified serious illness -- typically cancer, heart attack, stroke, and a list of other conditions defined in the policy wording.

For a key person in their 40s, statistically the more likely event over a ten-year term is a serious illness rather than death. Critical illness premiums are higher than equivalent term life premiums, but the payout can fund exactly the same business continuity costs.

Many businesses run both policies on the same key person, with the term life sum assured set higher (to cover capital debts and longer-term profit replacement) and the critical illness sum lower (to cover a two to three year recovery period).

The Tax Position -- When Premiums Are Deductible

HMRC guidance on key person insurance derives from the general trading expense rules in ITTOIA 2005 s52 (for unincorporated businesses) and the equivalent Corporation Tax Act provisions. HMRC's Business Income Manual (BIM45500 onwards) sets out the conditions in detail.

Premiums are deductible as a trading expense if all three of the following conditions are satisfied:

1. The insurance is on the life of an employee or officer of the business (not an owner-only sole trader).
2. The company or business is both the policyholder and the beneficiary of the policy.
3. The sole purpose of the policy is to indemnify the business against loss of profits caused by the death or serious illness of that person.

If any of those conditions fails -- for instance, if the policy also covers a capital sum or is used as security for a loan -- the premiums are not deductible.

When Premiums Are NOT Deductible

There are three common situations in which key person insurance premiums are treated as non-deductible capital expenditure:

• Protecting capital. If the purpose is to replace the business asset (goodwill, client relationships, intellectual property) rather than the profit stream, HMRC classifies this as a capital purpose and denies the deduction.
• Loan collateral. Where the policy is assigned to a lender, the premium is not a trading expense regardless of the underlying business purpose.
• Owner-only policies. A sole trader cannot insure themselves as a key person. The policy must be on a third party who is an employee or officer.

Tax Treatment of the Proceeds

The tax treatment of proceeds mirrors the treatment of premiums. This symmetry is fundamental to HMRC's approach.

• Premiums deductible -- proceeds taxable. If the business claimed a deduction for premiums, the payout is a trading receipt subject to corporation tax (for companies) or income tax (for sole traders and partnerships). There is no CGT position because the proceeds are revenue rather than capital in nature.
• Premiums not deductible -- proceeds may be exempt. If no deduction was claimed (because the policy protected capital), the proceeds are more likely to be treated as a capital receipt. In a company, this may attract corporation tax on chargeable gains, but often at a lower effective rate than trading income.

Practical example: A limited company pays GBP 3,600 per year in key person premiums for its sales director. It claims these as a deductible expense, saving GBP 720 per year in corporation tax at 20%. After five years (GBP 18,000 premiums paid, GBP 3,600 tax saved), the director suffers a critical illness. The insurer pays out GBP 500,000. That GBP 500,000 is a trading receipt. The company pays corporation tax on it -- but it still has GBP 400,000 to deploy for business continuity.

Relevant Life Policies -- A Tax-Efficient Alternative

A relevant life policy (RLP) is worth considering alongside or instead of traditional key person insurance for director-level individuals. The key differences are:

• The policy pays out to the employee's family or a nominated trust, not to the business.
• Premiums are deductible for the employer and are not treated as a P11D benefit-in-kind for the employee, provided the policy meets the conditions in ITEPA 2003 and the HMRC guidance in EIM21820.
• Because the policy sits outside the employee's estate (held in trust), it avoids inheritance tax on the payout.

RLPs cannot replace key person cover because the business does not receive the money -- but for companies where the directors are also shareholders, an RLP can run alongside a key person policy to provide personal family cover at lower tax cost than a company-funded individual life policy.

P11D Implications

Where a business takes out a policy that also benefits an individual employee -- for instance, a critical illness policy that would pay a lump sum to the employee personally rather than the business -- HMRC will treat the premiums as a benefit in kind reportable on a P11D form. The employee will pay income tax on the premium value and the employer will pay Class 1A NI at 13.8%.

To avoid an inadvertent P11D liability, ensure the policy wording and beneficiary designation clearly name the business as the sole beneficiary. Any split where part of the proceeds would go to the individual creates a benefit-in-kind problem.

Practical Checklist for Business Owners

Before arranging a key person policy, work through these questions:

• Is the proposed insured life an employee or officer of the business? If not, deductibility is unlikely.
• Is the business both policyholder and named beneficiary on all policy documents?
• Is the policy purpose documented in a board resolution as protecting trading profit rather than capital?
• Has the policy been assigned to any lender? If so, deductibility is lost.
• Has the sum assured been calculated using a profit multiple, debt cover, and replacement cost?
• Is a relevant life policy more appropriate for providing the key person with personal cover?

Key Person Insurance and Annual Accounts

From an accounting perspective, deductible premiums are expensed to the profit and loss account in the period they relate to. Pre-paid premiums (for example, where an annual premium is paid in advance of the year-end) are carried as a prepayment on the balance sheet.

Any payout received is posted as other income in the period it is received. If the payout is large relative to normal trading profit, it may be worth considering whether spreading provisions apply or whether the business needs to make a disclosure to Companies House or lenders who have financial covenants linked to profit levels.

Conclusion

Key person insurance is a straightforward commercial product but its tax treatment has genuine complexity. The deductibility of premiums turns on three strict conditions and fails entirely if the policy is used as loan collateral or covers a capital purpose. Where premiums are deductible, the symmetry rule means proceeds are fully taxable as trading income. Businesses should review the purpose of any existing policies against the HMRC tests and consider whether a relevant life policy running alongside the key person cover offers additional personal benefits for directors at lower overall tax cost.