Who Gets the Money From Key Person Insurance?

Key person insurance usually pays the business, not the family. In most cases, the company owns the policy and is named as beneficiary, so the death benefit goes to the company first. Who benefits in the end depends on the policy paperwork and any written agreement the owners have signed. This page explains each role and where the money goes.

Usually the company gets the money from key person insurance

On a company-owned key person policy, the business is usually the beneficiary. The death benefit is generally paid to the company, not to the insured’s family. The Insurance Information Institute explains that key person life insurance compensates a business for financial losses caused by the death of a key employee.

Start with the documents. The written policy and its beneficiary designation control who receives the money. If the family is named, or a separate agreement sends the money to them, the answer changes.

Owner, insured, and beneficiary in plain words

Three roles decide who controls a policy and who receives its money. The owner, the insured and the beneficiary can be three different people or entities.

• Owner: the party that controls the policy. The owner pays the premiums and can usually change the beneficiary.
• Insured: the person whose life is covered.
• Beneficiary: the party named to receive the death benefit.

Take a Florida company that owns a policy on its general manager. The company pays the premiums, so it is the owner. The general manager is the insured. The company is also the beneficiary. The family gets nothing from that policy unless a separate arrangement sends money to them.

Florida law also sets a consent rule. A business may insure its key persons only if it gets their written consent before buying the policy. The business may not retaliate against anyone who refuses. Under Fla. Stat. § 627.404, no one may procure insurance on another person’s life unless the benefits are payable to that person or their personal representatives, or to someone with an insurable interest in that person when the contract is made; the proposed insured’s signature on the application constitutes written consent.

How the company can use the proceeds

Once the death benefit is paid to the company, the company generally owns the money. The company’s owners then decide how to use it. The policy itself usually does not set a required use. A separate written agreement can.

Common uses include covering lost revenue during the transition, recruiting and training a replacement, meeting payroll and debt payments, and keeping cash flow steady while the business adjusts. These uses match the reason the coverage was bought.

Owners should write down the intended use before a claim arises. A short written plan, approved by the owners or board, shows what the policy was meant to cover. Waiting until a death means making those choices under pressure.

When a buy-sell agreement directs the money

A buy-sell agreement directs the money when the policy funds the purchase of a departing owner’s share. The agreement sets the price, the terms and who buys. Two structures are common:

• Entity redemption: the company buys the deceased owner’s interest, and the policy proceeds fund that purchase.
• Cross-purchase: the surviving owners buy the interest, and they may own policies on each other’s lives.

Under either structure, the agreement’s terms decide how money moves to the estate or family. Many business owners put buy-sell arrangements in writing so that the terms are clear to everyone involved. See Fla. Stat. § 607.0732. Under Fla. Stat. § 607.0732, an agreement among the shareholders of a corporation that complies with this section is effective among the shareholders and the corporation. Under Fla. Stat. § 605.0105, the operating agreement governs relations among members, except as provided in subsections (3) and (4). See Fla. Stat. § 605.0105.

If the proceeds are larger than the agreed price, the agreement should say how the difference is handled.

Tax and accounting points a CPA reviews

Life insurance paid by reason of death is generally excluded from gross income. IRC § 101 sets that general rule, but it also lists exceptions. Two matter here. If a policy is transferred for valuable consideration, the excluded amount is capped at the actual value of the consideration plus the premiums and other amounts the transferee later paid, unless one of the section’s listed exceptions applies.

Employers that own these contracts must file a return each year. IRC § 6039I requires the return to show the number of employees, the number of employees insured, the total insurance in force, the name, address, and taxpayer identification number of the applicable policyholder and the type of business it is engaged in, and whether a valid consent exists for each insured employee (or the number of insured employees for whom consent was not obtained).

Ownership can also reach the estate. IRC § 2042 includes, to the extent of the amount receivable by other beneficiaries, insurance on the decedent’s life under policies in which the decedent possessed at death any incidents of ownership, alone or with another person. IRC § 2042 reads: “For purposes of the preceding sentence, the term “incident of ownership” includes a reversionary interest (whether arising by the express terms of the policy or other instrument or by operation of law) only if the value of such reversionary interest exceeded 5 percent of the value of the policy immediately before the death of the decedent.” Treasury rules add a corporate twist. If the decedent was a controlling stockholder, the corporation’s incidents of ownership can be attributed to the decedent. See 26 C.F.R. § 20.2042-1.

On the accounting side, the CPA records the policy, premiums and any proceeds in the company’s books. Those entries should match the buy-sell agreement’s funding terms. The review checks owner and beneficiary designations, the issue date, the consent records, and the agreement’s funding terms. Whether the exclusion applies in full depends on the facts.

Bringing your policy and agreement to a coverage review

A coverage review checks who owns, who is insured and who is named on your policy. It also looks at how the proceeds would be used under your company’s agreements. This matters most when a business depends on one owner or key employee, and the policy and the buy-sell agreement do not match.

Nischay Rawal, a licensed insurance agent, reviews the policy and the agreements together. Insurance is offered through Nischay Rawal as a licensed insurance agent, separately from the accounting practice. When discussing insurance products, the agent acts as an insurance agent.

Florida law requires a CPA firm that accepts a commission on a sale to disclose that fact to the client in writing. See Fla. Stat. § 473.3205. Any accounting fee is quoted only after all of its variables are disclosed.

If your company depends on a key owner or employee, contact NR CPAs & Business Advisors to schedule a coverage review of your policy and agreement.

Frequently asked questions