Top Small Business Uses of Life Insurance—and One Mistake That’s More Common Than You Think
Most people consider life insurance a personal financial product—something you buy to protect your family. While that’s true, it’s only part of the story. When it comes to business, especially small businesses, life insurance can be a strategic tool for protection, planning, continuity, and retention.
And yet, many small business owners either overlook it or misuse it. One of the most common mistakes isn’t skipping coverage—it’s using the wrong type of policy for the wrong purpose. This guide explains the innovative ways to use small business life insurance—and the one mistake you’ll want to avoid at all costs.
1. Protecting Business Continuity With Key Person Insurance
Every business has someone it can’t afford to lose—often the founder, a top salesperson, or a critical technician. If that person were to pass away unexpectedly, the impact would be more than emotional. It could threaten revenue, operations, and client confidence.
Key person life insurance is designed for this exact scenario. The business takes out a life insurance policy on the key employee, pays the premiums, and is named the beneficiary. If the insured person dies, the company receives a payout to help cover financial losses, hire replacements, or even wind down operations in a more stable way.
2. Funding Buy-Sell Agreements Between Co-Owners
In partnerships or multi-owner businesses, buy-sell agreements are critical. These legal contracts outline what happens if one owner dies, becomes disabled, or wants to leave. But a contract alone isn’t enough—you need the funds to execute it. That’s where life insurance comes in.
Each partner takes out a life insurance policy on the other. If one partner passes away, the surviving partner uses the death benefit to buy out the deceased’s share of the business from their estate. This ensures:
- A smooth ownership transition
- The family of the deceased receives fair compensation
- The business continues operating without interruption
This is one of small business life insurance’s most common and practical uses, especially in closely held companies.
3. Providing Executive and Employee Benefits
Small businesses often struggle to compete with larger firms on salary, but life insurance can be a creative way to strengthen your benefits package. Offering life insurance shows employees you’re thinking about their future, not just their work.
Here are two popular ways to use it:
A. Group Term Life Insurance
This employer-paid policy is offered to all or some employees, often as part of a group benefits package. It’s usually affordable and easy to administer, with fixed coverage amounts.
B. Executive Bonus Plans
For high-level team members, an executive bonus plan (sometimes called a Section 162 plan) involves the company paying premiums on a life insurance policy owned by the employee. The employee names their beneficiary, and the company treats the premium as taxable income.
These plans can help you retain top talent while offering a meaningful, long-term benefit.
4. Collateral for Business Loans
Small business loans often require some form of collateral. Life insurance can play that role if your business doesn’t own property or large assets.
Lenders may require a life insurance policy on the owner or key executive as a loan condition. This reassures them that the loan will be repaid if the insured dies.
In this case:
- The lender is named as the primary beneficiary for the amount of the loan
- The business or owner pays the premiums
- Once the loan is paid off, the beneficiary designation can be changed or removed
It’s a simple way to improve your loan application and protect your business’s financial stability.
5. Building Cash Value as a Financial Reserve
Some life insurance policies, like whole or universal life, include a cash value component. Over time, this grows tax-deferred and can be accessed through policy loans or withdrawals.
Small business owners sometimes use this feature as a way to:
- Supplement retirement income
- Fund a buyout or succession plan.
- Cover emergency expenses
- Provide flexible access to capital.
While it’s not a substitute for traditional business savings or investments, it can be a low-risk, long-term financial tool, primarily when appropriately structured with the help of a financial advisor.
The Most Common Mistake: Choosing the Wrong Type of Policy
Many small business owners make a mistake when buying personal life insurance: they assume it covers the business, too. Or, they use the wrong policy type for the goal they’re trying to achieve.
Example:
You take out a personal term policy but want to fund a buy-sell agreement. Upon death, the payout goes to your family, not your co-owners, because there’s no legal structure tying the policy to the business. Or, you buy a term policy expecting it to build cash value for retirement—something only permanent life insurance provides.
That’s why it’s critical to:
- Understand the purpose of each policy
- Assign the right owners and beneficiaries
- Match the coverage amount and structure to the business use
Tip: A business attorney or advisor with experience in small business life insurance should review any policies tied to operations, ownership, or employee retention.
Conclusion
Small business life insurance helps preserve continuity, attract and retain great people, fund legal agreements, and secure financing. Yet the most common mistake is treating it like a personal product, without thinking through structure, beneficiaries, or business use cases.
If your business would struggle financially from the loss of a key person, an unfunded buy-sell agreement, or a missed loan payment, it’s time to act. Need help choosing the right structure? Speak with a licensed advisor who understands your business and long-term goals, so your coverage works when you need it most.
