Key Person Insurance for Adult Children in a Family Business

The next key person in a family business is often an adult child who is learning the work now. Key person insurance for adult children in a family business is life insurance the company can own to offset a financial loss if that person dies. This page offers general information about identifying a key person in a business and how a succession plan can fit in. It is written from a CPA’s view of tax and cash flow. Insurance is offered by Nischay Rawal, a licensed insurance agent, separately from the accounting practice of NR CPAs & Business Advisors in Miami.

Who Is the Key Person in a Family Business Today?

A key person is someone whose death or long-term disability would cost the company money. The loss can show up as lost sales, lost customers, or lost know-how. The Insurance Information Institute explains that key person life insurance guide pays a business to offset that kind of loss.

Often the key person is the parent who founded the company. It can also be a sales lead, a technical lead, or the person who holds a major supplier or client relationship.

Try this simple test. List each role in the company. Next to each role, write the name of the person who does it today. Then ask: what would stop if that person could not work? The names you write down are your candidates.

Roles change over time. Review the list each time a responsibility moves to someone else.

Why Is the Adult Child Often the Next Key Person?

An adult child often becomes a key person long before owning any shares. The parent still runs the company. The child learns the operations, the client relationships, or the books.

A job title is not the same as ownership. You may hold a role the company relies on while owning little or nothing. That gap affects who can be insured and who receives any proceeds.

Under federal tax law, the term ‘key person’ in IRC § 264 applies only for purposes of that section’s interest-deduction rule for policy loans, not as the general meaning of key person for insurance. Under IRC § 264, a key person is an officer or a 20-percent owner, and the number of people treated that way is capped. IRC § 264 says that, for its interest-deduction rule, a key person is an officer or 20-percent owner, and the number treated as key persons is capped; one limb of that cap is the lesser of 5 percent of the total officers and employees or 20 individuals.

You may be helping a parent through a health problem while keeping the business moving. That is a heavy load. Planning for the company’s cash flow can ease part of it, and that planning does not have to happen in a crisis.

What Is Key Person Insurance, and How Is It Different From a Buy-Sell Agreement?

Key person insurance is a life insurance policy the business owns on a key individual. The company is named as beneficiary, receives the death benefit, and decides how to use it. The money may cover lost revenue, recruiting and training a replacement, or debts.

A buy-sell agreement is a different tool. It is a contract among owners that sets how one owner’s share is bought when that owner dies, retires, or becomes disabled. Owners often fund it with life insurance.

The two answer different questions. Key person coverage asks how the company absorbs a loss of income and skill. A buy-sell agreement asks who buys an owner’s share, and on what terms. Many family companies use both.

Policies are described by their generic names, such as whole life insurance policy or term life insurance policy. When a specific policy is discussed, the insurer is named.

Who Can a Florida Business Insure? Insurable Interest Explained

A Florida business can insure a key person when it has an insurable interest and the key person agrees in writing before the policy is bought. An insurable interest is a financial stake in the person’s continued life.

Under Fla. Stat. § 627.404, a business can have an insurable interest in its owners, directors, officers, partners, managers, and key employees or key persons. Written consent must be obtained before the insurance is purchased. The business may not retaliate against a key employee who refuses consent.

Florida tests insurable interest when the contract is made. Fla. Stat. § 627.404 reads: “(1) Any individual of legal capacity may procure or effect an insurance contract on his or her own life or body for the benefit of any person, but no person shall procure or cause to be procured or effected an insurance contract on the life or body of another individual unless the benefits under such contract are payable to the individual insured or his or her personal representatives, or to any person having, at the time such contract was made, an insurable interest in the individual insured.” Under Fla. Stat. § 627.404, the insurable interest need not exist after the inception date of coverage under the contract.

Bring these questions to the table. Which role produces the company’s revenue? Does the business have a documented financial stake in that person? Is the parent an owner, an employee, or both?

Who Owns the Policy, Who Pays, and Who Gets the Benefit?

In a typical key person policy, the business owns the policy, pays the premiums, and receives the death benefit. The key person is the insured. Because the insured is a separate person, that person’s written consent is required.

Under 26 U.S.C. § 101, amounts received because of the insured’s death are generally excluded from gross income. For an employer-owned life insurance contract, § 101(j) limits the exclusion to the premiums and other amounts the policyholder paid, unless the employee received written notice and gave written consent before the contract was issued and one of the statute’s exceptions applies, such as one based on the insured’s role or on who receives the proceeds. Transfers of a policy to a buyer for valuable consideration can also limit that exclusion. Interest paid on proceeds left with the insurer can be taxable, according to the IRS life insurance proceeds FAQ.

Tax treatment depends on the facts. Our CPA view looks at how the premiums and any proceeds affect the company’s cash flow.

An adult child who will later own shares should understand each party’s role before signing. Ownership changes once a buy-sell agreement is in place.

Succession Plan or Key Person Coverage: Which Fits a Family Company?

A succession plan decides who leads the company and when ownership moves. Key person coverage gives the company money to cover a loss if a key person dies before that plan is finished.

A succession plan is a business and legal plan first. It names who leads, how duties shift, and when ownership transfers. Key person coverage gives time and cash to fill a role. It does not name the next leader or move ownership.

Many family companies need both. They need a written plan for leadership and ownership, plus funding that protects operations while the plan is carried out.

If an owners’ agreement is used, Florida law sets formalities.

If a whole life insurance policy is discussed with dividends, the statement must say dividends are not guaranteed. Florida law requires insurers to deliver certain information to purchasers of life insurance.

Take the Next Step With a Coverage Review

The next step is a coverage review with NR CPAs & Business Advisors. We map the key roles, insurable interest, and ownership questions for your company.

Maybe you run the books, keep the client relationships, or carry a large share of the work. If the company would struggle when you stop working, your role matters. Our team can walk through it with you.

A coverage review is our first meeting. Nischay Rawal, a licensed insurance agent, reviews the roles to protect, the ownership structure, and how a buy-sell agreement or succession plan fits. The review also covers what the company must decide before any application.

NR CPAs & Business Advisors is a Miami CPA firm. It helps families, professionals, and business owners, including Indian-American households and business owners across the United States, choose and buy life insurance.

Nischay Rawal is acting as a licensed insurance agent. Under Fla. Stat. § 626.9531, agents must say so when selling insurance. Insurance is offered separately from the accounting practice. The insurer is named for any specific policy we discuss.

To request a coverage review, visit our contact page.

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