How Much Key Person Cover Does a Small Company Need?

Working out how much key person insurance you need is a build-up, not a guess: add the gross profit the business would lose while it replaced the person, the cost of recruiting and training their successor, and any borrowing that would have to be repaid — then do the one step almost every published formula leaves out, which is adjusting the total for the tax the payout may itself attract. Get that last step wrong and the cover pays out a sum that looks right and lands short.

The reason so much online guidance produces the wrong figure for a small company is that it stops at a tidy multiple of profit or salary. A multiple is a starting point, not an answer. What a small UK company actually needs is a number built from its own numbers — its own margin, its own recovery time, its own loan covenants — and then grossed up if the proceeds would be taxed in its hands. This page sets out that method in the order you would actually work through it.

Two things before the detail. Key person cover is arranged by the business, on the life of the person it cannot easily do without, and it pays the business, not the family. And nothing here is a personal recommendation about a specific sum for your company — it is the method a broker and an accountant would use with you, laid out so you can follow it.

The short answer: build it up, then gross it up

A defensible key person figure has two movements. First you build up the gross need — the money the company would actually have to find if it lost this person — by adding the separate things that money has to do. Then, if the payout would be taxable in the company, you gross the whole thing up so that what survives tax is the amount you first calculated. Skipping the second movement is the commonest and most expensive mistake, because it is invisible until a claim, when the shortfall appears at the worst possible moment.

The build-up has three components: lost gross profit while the business recovers, the cost of replacing the person, and any borrowing that falls due or has to be repaid on their death. The tax adjustment is a fourth step applied to the sum of the first three. Take them one at a time, because each has a trap that a flat multiple hides.

Start with lost gross profit, not turnover

The largest component is usually the profit the business would lose while it operated without the person and while a replacement got up to speed. The mistake here is to reach for turnover. Turnover overstates the loss wildly, because most of it is costs that fall away or continue regardless; what the business actually loses is the margin the person was responsible for generating, not the revenue that passed through their hands.

So use gross profit, and specifically the share of it attributable to that individual. In a small firm where one person wins the work or holds the key relationships, that share can be large; in a more evenly spread business it is smaller. Then multiply it by a realistic recovery period — how long the business would genuinely take to replace the capability and return to its previous run rate. There is no fixed rule for that period; a common range is two to five years, chosen honestly rather than optimistically. A business that would take three years to recover and loses a clear slice of gross profit each year needs cover for that slice across those years, not a single year's figure.

Be realistic about the recovery curve, too. The loss is rarely flat — it is often worst in the first year and eases as a successor beds in — so estimating a declining loss across the recovery period tends to give a truer number than multiplying one year by a round figure.

Add the cost of replacing the person

The second component is the direct cost of putting a successor in place, and it is separate from the lost profit because it is money spent, not margin foregone. It includes recruitment — agency or search fees, advertising, and management time diverted to hiring — and then the cost of bringing the new person up to the standard of the one who died.

That second part is easy to underestimate. A senior replacement may need a period at full salary before they are fully productive, may command more than the person they replace, and may need training, handover or overlap that costs real money. In a small company the person who dies is often irreplaceable in the short term precisely because knowledge lived in their head, so the replacement cost is not just a salary line — it is the cost of rebuilding capability the business had stopped noticing it depended on. A candid tour of that dependency is set out in the sibling questions around succession, including what happens when shares pass to a child who cannot be a director, where ownership and capability come apart.

Add borrowing and lender covenants

The third component is debt. If the company holds a loan, an overdraft or asset finance that would need repaying on the owner's death, or that a lender could call in once the key person had gone, add the amount that would have to be found. This is money the business must produce regardless of how well it recovers, so it sits on top of the profit and replacement figures rather than overlapping them.

Two cautions here. First, some facilities are backed by a personal guarantee or a charge over the owner's home, which is a personal exposure the family carries rather than a company one, and it is best dealt with by cover arranged around the estate — a different job from key person cover, and one we treat separately. Second, and specific to sizing, a lender covenant can dictate the figure. Where a bank made cover on the key person a condition of the facility, the amount it requires may be higher than your own calculation produces, and the covenant wins — so read the facility letter before settling on a number, and make sure the business itself, not just the family, is the one the money reaches, a point drawn out in why key person cover pays the company and not your family.

The step every formula skips: tax on the payout

Here is the component the tidy multiples ignore. Whether a key person payout is taxed depends on how the premiums were treated. Broadly, where the premiums were claimed as an allowable business expense, the proceeds are generally taxed as a trading receipt of the company; where they were not deductible, the proceeds are more likely to fall outside the charge. The treatment is not automatic and turns on the facts, which is why it needs an accountant — we set out the linkage in why, if key person premiums are deductible, the payout is taxed.

The practical consequence for sizing is simple arithmetic. If the proceeds will be taxed, the company does not keep the whole payout, so the cover has to be set high enough that the amount left after tax equals the net figure you built up. The mechanic is to divide the net amount needed by one minus the company's corporation tax rate. A company that needs a particular net sum, and whose proceeds would be taxed at the main rate, has to insure for meaningfully more than that sum to end up with it.

The rate to use is the company's own. The main rate of corporation tax is 25%, with a small profits rate of 19% for companies whose profits are under £50,000 and marginal relief tapering between £50,000 and £250,000, so a smaller company may be grossing up at a lower rate than a larger one.

Source: HM Revenue and Customs and HM Treasury, Corporation Tax rates and allowances, gov.uk, published under the Open Government Licence. See the current figures at gov.uk's Corporation Tax rates page.

Putting the number together

Set the pieces side by side. Take the gross profit attributable to the person, spread across a realistic recovery period and tapering as a successor beds in. Add the full cost of recruiting and rebuilding the capability. Add any borrowing that must be repaid or that a covenant requires be covered. That sum is your net need — the amount the company must actually have in hand.

Then apply the tax step. If the proceeds would be taxable, gross the net need up by dividing it by one minus the applicable corporation tax rate, so the post-tax amount matches what you built. If the proceeds would not be taxable, the net need is the figure. The result is a sum assured grounded in the company's own economics rather than a multiple pulled from the air — and, importantly, one you can explain to a lender, an accountant or a co-owner, because every part of it traces back to a real number.

Do not let the arithmetic imply false precision. The recovery period, the profit share and the replacement cost are all estimates, and the point of the method is to make those estimates explicit and defensible, not to pretend they are exact. A figure you can justify beats a rounder figure you cannot.

Owning the cover, reviewing it, and the UK-wide position

Two final decisions shape whether the figure does its job. The first is ownership: key person cover for a company is normally taken out and owned by the company on the life of the key individual, which keeps the proceeds pointed at the business that needs them. That is deliberately different from personal or family cover, and from cover arranged to clear a personal guarantee, which belongs outside the company. The second is review. The right sum moves as the business grows, as borrowing rises or falls, and as the person's role changes, so a figure set once and forgotten drifts out of line — treat it as something to revisit annually, alongside the accounts.

The sizing method itself is UK-wide, because corporation tax and company law apply across the United Kingdom in the same way; there is no separate Scottish or Northern Irish key person calculation. What differs across the UK is not the cover but the estate machinery around the owner's death — for example, a modest estate in Scotland may be dealt with through the small estate confirmation route at the sheriff clerk's office, explained in small estate confirmation in Scotland and the sheriff clerk. That affects how the family proves authority, not how much cover the company needs. Money the business is owed can also keep arriving after a death, sometimes taxed as a post-cessation receipt, which we cover in invoices that pay after death and how post-cessation receipts are taxed — a reason not to double-count that income when sizing the shortfall. The rest of this topic sits in our guide to what dies with a business owner. When you are ready to price cover against a figure you have built, you can get life insurance quotes through an FCA-authorised broker.

Frequently asked questions

How do I work out how much key person cover we need?

Start with the gross profit the business would lose while replacing the person, spread over a realistic recovery period, then add the cost of recruiting and training a successor, then add any borrowing that would have to be repaid. That gives the net amount the company needs. Finally, if the proceeds would be taxable in the company, gross the total up so the amount left after tax is the sum you actually require.

How many years of profit should be covered?

There is no fixed rule. A common approach is to estimate how long the business realistically needs to recover, often somewhere between two and five years, and multiply the profit attributable to that person accordingly, ideally tapering the loss as a successor beds in. Lender covenants sometimes require a higher figure than the calculation produces, in which case the covenant sets the minimum.

Why does tax change the amount?

Because where the premiums are treated as an allowable business expense, the proceeds are generally taxed as a trading receipt. If the company needs a particular net sum, the cover has to be set higher so that the amount left after corporation tax is the amount actually required. Whether the proceeds are taxable turns on the facts and the way the premiums were treated, so confirm the position with an accountant before fixing the figure.