Can a Business Use Key Person Insurance Cash Value?

A business can use key person cash value only in the ways the policy contract and tax law allow. Cash value is not cash the company holds in a bank account. It is a contract value that follows the policy’s terms. This guide explains what cash value means, how guaranteed and non-guaranteed figures differ, how a policy loan works, and what to ask your CPA.

What cash value means in a key person whole life policy

Cash value is the value a whole life insurance policy builds over time under its contract. It is separate from the death benefit. The death benefit is the amount the insurer pays when the insured person dies.

Key person insurance is a policy the business buys on the life of an officer or key owner. The business usually owns the policy, pays the premiums, and is the beneficiary. The Insurance Information Institute explains that key person life insurance compensates a business for financial losses caused by the death or disability of a key employee.

Cash value is not a bank account, and it is not a promise of returns. Whole life policies include a cash-value feature, as FINRA’s guide to insurance products explains. The cash surrender value is the amount the policy pays the owner if it is ended early. Ask the insurer for that figure in writing before you act on it.

Guaranteed and non-guaranteed values, shown separately

Guaranteed values are the figures the contract promises. Non-guaranteed values can be higher or lower than an illustration shows. A policy illustration or annual statement should list the two groups separately.

Read the guaranteed figures first. Then read the non-guaranteed figures and note that they can change. If a policy pays dividends, those dividends are not guaranteed. Don’t treat a projected dividend as a fixed number in the company’s records.

A growth or interest illustration always comes with limitations. Give those limitations the same weight as the projected numbers. In a coverage review, we go through each column with you so you can see which figures the contract guarantees and which are projections.

Questions to bring to your CPA about the books

Start with three questions. First, which cash value figure belongs in the company’s financial statements, and how the policy appears there. Second, how the cash surrender value differs from the death benefit, and why both matter to the records. The death benefit is paid at death. The cash surrender value is what the owner can receive by ending the policy.

Third, who is shown as owner and beneficiary, and how a change in either would be recorded. A common mistake is treating a projected figure as if the contract guarantees it. The business’s entity type also matters. Your CPA should review the structure and the policy terms together.

How premiums and policy proceeds are treated for tax purposes

Premiums, loan interest and death benefits each have their own tax rules. Keep them separate when you talk with your CPA.

Section 264 limits some deductions tied to life insurance borrowing. Under 26 U.S.C. § 264, any amount paid or accrued on debt incurred or continued to purchase or carry a life policy (other than a single premium contract or a contract treated as one) is not deductible when that debt is part of a plan of purchase that contemplates systematic direct or indirect borrowing of part or all of the increases in the policy’s cash value, except as provided in subsection (d).

Death benefits follow a different rule. The IRS states that life insurance death benefits are generally not taxable income. Interest paid on proceeds held by the insurer is taxable, per IRS guidance on life insurance proceeds.

The records an insurer asks for are covered in documents the insurer asks for.

How policy loans work at a high level

A policy loan is a loan from the insurer, secured by the policy. It is not a withdrawal from a bank account. Florida law sets some basic terms. Under Fla. Stat. § 627.458, after a policy has a cash surrender value and no premium is in default, the insurer will advance a loan on the policy as its sole security. 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 amounts the insurer may deduct. 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.”

Unpaid interest matters. If the policy provides for it and interest is not paid when due, the unpaid interest is added to the debt and bears interest at the same rate. If total debt equals or exceeds the loan value, the policy terminates after at least 30 days’ notice mailed by the insurer. The insurer may also defer a loan for six months after application, except for a premium payment. That section does not apply to term policies.

Loan interest can also raise tax questions under section 264. Ask your CPA before you borrow. The loan terms are set in the policy contract, so confirm them with the insurer and the licensed agent first.

Before any loan or surrender, schedule a coverage review

Before a loan or surrender, a coverage review is the right first step. A coverage review is our first meeting. We go through the policy, its cash value, the guaranteed and non-guaranteed figures, and the loan or surrender question together. The decision stays with you and your CPA.

Florida law adds a safeguard for surrenders. Under Fla. Stat. § 627.4553, if an agent recommends surrendering a policy with cash value and does not recommend using the proceeds to buy another policy, the agent must give written information first. That information includes estimated surrender charges, loss of minimum interest guarantees, possible tax consequences and any forfeited death benefit.

Nischay Rawal acts as a licensed insurance agent for insurance matters. Insurance is offered separately from our accounting practice. Fees for a coverage review are explained in writing before any engagement.

Is key person insurance worth it for your business?

Whether key person insurance fits a business turns on how much the company relies on one person. It also turns on how the policy fits the company’s plans. Common uses include keeping business plans steady if a key officer or owner dies or becomes disabled. Other uses include funding a buy-sell agreement among owners and supporting estate planning in a family business.

Florida law sets a consent rule. Fla. Stat. § 627.404 provides that a business entity has an insurable interest in the life, body, and health of the owners, directors, officers, partners, and managers of the business entity or of any affiliate or subsidiary, and of key employees or key persons of the business entity or affiliate or subsidiary, if those key employees or persons give written consent before the insurance is purchased; the statute defines a key employee or key person as an individual whose position or compensation is described in section 101(j)(2)(A)(ii) of the Internal Revenue Code. The business may not retaliate against a key person who does not consent. The signature of the proposed insured, if that person has legal capacity to contract, on the application for insurance can serve as that written consent.

Florida owners can read more on Florida key person insurance. Businesses with several owners can review multi-owner LLC situations.

Talk with us about the policy in your company’s books

Picture a business that has lost a senior officer. Its owners are now weighing a loan against the key person policy. Before they borrow, they need to know what the books should show and what the loan could cost. If your company faces that decision, schedule a coverage review with NR CPAs & Business Advisors.