Key Person Insurance: Recording the Accounting Entries Clearly

Key Person Insurance Accounting Entries

Key person insurance accounting entries show how a company records the premiums, cash value and death benefit on a policy it owns on a key person. The short answer: the company is the owner and beneficiary, so its books carry the policy, not the insured. Key person insurance, also called key man insurance, is life insurance a business buys on an owner or key employee whose loss would hurt its operations; under Florida law, the business must obtain that person’s written consent before the insurance is purchased. How each piece is recorded depends on the policy design and the entity type. Treat the examples below as a map, not a template.

What the Books Need to Show for a Key Person Policy

The company, not the insured, owns the contract, so the company’s books carry the policy and its values.

Key person life insurance helps a business cover financial losses caused by an employee’s death or disability, according to the Insurance Information Institute. The money goes to the company. It can help with lost revenue, recruiting a replacement or steadying operations.

A personal life policy works differently. The insured owns it and names a family member as beneficiary, so the business has nothing to record. With a key person policy, the company holds the contract, pays the premiums and records the cash value as its own asset. For the full overview, read the key person insurance guide. For a side-by-side view, see key person insurance vs personal life insurance.

Florida law adds a step before the policy is bought. A business may insure an owner, director, officer, partner, manager or key employee on the basis of its insurable interest only if it gets written consent from that person before the insurance is purchased, under Fla. Stat. § 627.404. Keep that signed consent in the company file.

Recording Premiums: Expense, Asset, or Prepaid

Premiums on a key person policy are generally not deductible for federal income tax when the business is the beneficiary. Federal law says no deduction is allowed for premiums on a life insurance policy when the taxpayer is directly or indirectly a beneficiary, under IRC § 264(a)(1).

That rule affects your bookkeeping. A premium you post as an expense may still need an adjustment on the tax return. Keep the book entries and the tax entries separate so the return can be reconciled to the ledger.

Next, decide whether the premium builds cash value or only pays for coverage. On a whole life policy, the premium usually splits between the cost of insurance and the cash value. Your annual policy statement shows that split. Record from the statement, not from the bill.

Annual premiums paid in advance are generally recorded as a prepaid asset and spread over the coverage period. Term policies build no cash value, so their cost is usually expensed over the period it covers. The right treatment depends on the facts of your policy and entity, so confirm it with your CPA before you post.

Cash Surrender Value on the Balance Sheet

The cash surrender value is the amount the insurer would pay if the policy were surrendered, as shown on the annual statement. Use that statement to set the balance sheet amount, and reconcile the book value to it each year.

Federal law also sets a basic test. A policy must meet the federal definition of life insurance under IRC § 7702. If a contract that is life insurance under state law fails that test, the income on the contract for the year is treated as ordinary income to the policyholder.

A policy is a contract with the insurer. It is not a savings or investment account, and growth shown in an illustration is not a promise. Show guaranteed values and non-guaranteed values on separate lines. That way, no one reads an estimate as a fixed number.

Policy Loans, Dividends, and Non-Guaranteed Amounts

A policy loan is a debt to the insurer. It reduces the value the company can reach from the policy.

Under Fla. Stat. § 627.458, once a policy (other than a term policy, and not counting term insurance benefits provided by riders or supplemental policy provisions) has cash surrender value and no premium is in default, the insurer will advance money on a proper assignment or pledge of the policy, though the policy reserves the insurer’s right to defer a loan (other than one to pay a premium) for up to 6 months after you apply. Fla. Stat. § 627.458 reads: “The loan value of the policy shall be at least equal to the cash surrender value at the end of the then-current policy year, except that the insurer may deduct, either from such loan value or from the proceeds of the loan, any existing indebtedness not already deducted in determining such cash surrender value, including any interest then accrued but not due, any unpaid balance of the premium for the current policy year, and interest on the loan to the end of the current policy year.” The loan value must be at least equal to the cash surrender value at the end of the current policy year, minus the deductions the statute lists. Fla. Stat. § 627.458 reads: “The loan value of the policy shall be at least equal to the cash surrender value at the end of the then-current policy year, except that the insurer may deduct, either from such loan value or from the proceeds of the loan, any existing indebtedness not already deducted in determining such cash surrender value, including any interest then accrued but not due, any unpaid balance of the premium for the current policy year, and interest on the loan to the end of the current policy year.” That section does not apply to term policies or term riders.

Record the loan as a liability. Record interest as it accrues under the loan terms. Federal rules also limit the deduction for interest on these loans.

Dividends on participating whole life policies are not guaranteed. Record a dividend only when the insurer declares it, and keep any dividend-purchased additions apart from guaranteed values.

Recording Death Proceeds Against Policy Basis

When the insurer pays a death benefit, the company removes the policy’s carrying amount and records the cash it receives.

Under IRC § 101(a), amounts paid by reason of the death of the insured under a life insurance contract are generally excluded from gross income, except as otherwise provided in paragraphs (2) and (3), subsection (d), subsection (f), and subsection (j). The IRS also states that interest received on the proceeds is taxable, in its FAQ on life insurance proceeds.

Florida also requires interest on lump-sum death payments. Under Fla. Stat. § 627.4615, when a policy pays its proceeds in a lump sum on the insured’s death, the payment must include interest at an annual rate equal to or greater than the Moody’s Corporate Bond Yield Average-Monthly Average Corporate as of the day the claim was received, from the date the insurer receives written due proof of death.

Employer-owned contracts issued after the statute’s enactment also carry an annual filing and consent-record duty under IRC § 6039I. Keep the premium history, annual statements, loan records and transfer papers together. Those documents let you rebuild the tax basis when a claim is paid.

Worked Journal Entries With Hypothetical Figures

The entries below use invented amounts to show the flow of key person insurance accounting entries. They are not a template for any company.

1. Annual premium, $10,000 (hypothetical). Debit cash surrender value (asset) $10,000; credit cash $10,000. This assumes the full premium builds cash value. A split design changes the debit lines.
2. Annual statement, cash surrender value up from $40,000 to $46,000 (hypothetical). Record the guaranteed $5,000 increase as the statement shows it. Carry the $1,000 non-guaranteed amount on a separate line, marked as not guaranteed, and adjust it when the next statement arrives.
3. Policy loan of $20,000 with $1,600 accrued interest (hypothetical). Debit cash $20,000; credit policy loan payable $20,000. Then debit interest expense $1,600; credit accrued interest payable $1,600.
4. Death proceeds of $500,000, no loan outstanding (hypothetical). Debit cash $500,000; credit cash surrender value (asset) $46,000; credit gain on policy proceeds $454,000. This is a book entry only. The tax result follows the section 101 rules above.

Actual entries depend on the policy design and entity type.

Next Step: Review Your Policy and Books Together

If your company holds a key person policy, a coverage review can match your records to the policy and the entity structure. Insurance is offered through Nischay Rawal, a licensed insurance agent, separately from the accounting practice of NR CPAs & Business Advisors.

For the steps involved, read the key person insurance coverage review guide. Family-owned companies may also find key person insurance for adult children in a family business useful.

If your company owns a key person policy and you’re not sure how its premiums, cash value or a future claim belongs in your books, our team can walk through it with you in a coverage review.