Key Person Policy Cash Value Loans: A Guide for Business Owners

A key person policy cash value loan lets a business borrow from the insurance company, using the policy’s cash value as security. Only permanent policies, such as whole life, build cash value. Term key person policies do not. Before borrowing, a business should know how the loan affects the death benefit, whether the policy can lapse, and what taxes may apply.

This page explains those points in plain words. It is written for business owners in Miami, Fort Lauderdale, West Palm Beach, Orlando, Tampa and Jacksonville, and for owners across the United States, including Indian-American business owners. NR CPAs & Business Advisors is a Miami CPA firm. Insurance is offered by the licensed agent, Nischay Rawal, separately from the accounting practice.

What a Key Person Policy Is and Who It Is For

A key person policy is life insurance that a business owns on the life of a key employee. The business pays the premiums and is the beneficiary.

Key person coverage compensates a business for financial losses caused by the death of a key employee, according to the Insurance Information Institute guide.

A key employee is an owner, executive or staff member whose loss would hurt the company’s operations or revenue. Owners often buy coverage on a partner or top manager whose work drives sales. A business might also insure a founder whose skills it cannot easily replace.

The business owns the policy, pays the premiums and receives the death benefit. The employee does not own the policy. This page covers permanent policies only, because those are the only key person policies that build cash value.

Which Key Person Policies Build Cash Value

Only permanent life insurance, such as whole life, builds cash value. Term coverage pays a death benefit but builds no cash value.

Cash value is the amount a policy accumulates over time. The insurer holds it, and it appears alongside the death benefit. Cash surrender value is the cash value the owner would receive by ending the policy. Any outstanding policy loan, plus the interest that has built up on it, is generally subtracted from what the policy pays, whether the business surrenders the policy for its cash value or the insured person dies and the death benefit is paid.

• Guaranteed values are amounts the policy contract promises. Check the contract for these figures.
• Non-guaranteed values depend on things the contract does not promise, such as dividends.
• Dividends, where a policy pays them, are not guaranteed.
• Illustrations are projections, not promises. Read their limits as closely as their numbers.

The Florida Department of Financial Services guide explains cash value, policy loans and beneficiaries in plain terms.

How a Policy Loan Against Cash Value Works

A key person policy cash value loan is money the insurer lends to the policy owner. The policy’s cash value secures the loan. The policy is not sold to raise the money.

Florida law sets the basic terms. A loan is available after the policy has a cash surrender value and while no premium is in default (Fla. Stat. § 627.458). 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, less certain deductions. 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 insurer may delay granting a loan for 6 months after the application, except for a premium payment.

Interest works against the owner.

Lapse is the largest risk. If total debt equals or exceeds the loan value, the policy can end. Under Florida law, the insurer must first mail at least 30 days’ notice to the last known address of the insured or policyowner and of any assignee of record at the home office of the insurer (Fla. Stat. § 627.458).

The business can repay the loan in whole or in part. Check the loan rate in the policy contract before borrowing.

Tax Treatment of Loans and Withdrawals

Tax results depend on the facts of each policy and business, including how the policy ends.

• Death benefit. Amounts paid because of death are generally excluded from gross income under 26 U.S.C. § 101.
• Employer-owned policies.
• Yearly reporting. Employer-owned contracts issued after the statute’s enactment require a yearly return, per 26 U.S.C. § 6039I.
• A CPA should review the numbers before any decision.

Risks and Common Questions Before Borrowing

The main risks are a rising loan balance, a smaller death benefit and a lapse with tax results.

• A rising balance. Unpaid interest adds to the debt.
• A smaller death benefit. The unpaid balance reduces what the insurer pays.
• A lapse. The policy can end if debt reaches the loan value, but not until at least 30 days’ notice has been mailed by the insurer to the last known address of the insured or policyowner and of any assignee of record at the insurer’s home office.

Replacing or surrendering a policy can carry its own costs and rules. When an agent recommends a surrender and not the use of the proceeds for another policy, written information must come first (Fla. Stat. § 627.4553).

Before any loan, confirm the current cash value, the loan balance, the loan rate and whether any premium is in default. Read the latest annual statement too.

Finally, judge the loan against the company’s plan. Ask what the money is for, and whether the policy still fits that plan.

How a Coverage Review Works

A coverage review is the first meeting, held before any loan decision. We look at the policy, the company’s needs and the tax picture together.

1. Gather the policy contract, the latest annual statement, and ownership and beneficiary records.
2. Identify the key employee, the coverage amount and why the business bought the policy.
3. Review guaranteed and non-guaranteed values, the loan balance, the interest rate and lapse risk.
4. Model the loan and its effect on the death benefit and on tax reporting.
5. Decide with the business’s own advisors whether to keep, adjust, borrow or make no change.

Our team, including assistants and office staff, helps gather the records in step 1.

Why Work With NR CPAs & Business Advisors

NR CPAs & Business Advisors is a Miami CPA firm. It helps families, professionals and business owners choose and buy life insurance, with a CPA’s view of tax and cash flow.

• Tax and cash flow. The firm reviews a policy’s numbers alongside the business’s tax and cash flow picture.
• Licensed agent. Insurance is offered by the licensed agent, Nischay Rawal, separately from the accounting practice.
• Commission disclosure. The agent is paid commission on policies sold. The commission is disclosed in writing before any engagement.
• Plain language. Explanations are given in English, for Indian-American households and business owners, without jargon.
• Support staff. Assistants and office staff help gather policy records and schedule the coverage review.

Frequently Asked Questions