Key Person Insurance When an Employee Leaves: Your Options

What Happens to Key Person Insurance When the Key Employee Leaves

Short answer: who decides what happens to the policy

The business that owns the policy decides. When a key employee leaves, the company can keep the policy, transfer it to the employee, or surrender it for its cash value. The employee does not take the policy just because they are leaving.

If you are asking what happens to key person insurance when employee leaves, the answer starts with ownership. In most arrangements, the business is the owner and beneficiary. That means the company makes the call.

Treat the departure as a decision point, not an afterthought. Review the policy file, the company’s records and any buy-sell agreement before the employee’s last day. Waiting can leave the business paying for coverage it no longer needs, or dropping coverage it still needs.

Three questions usually decide the path. Does the company still have a reason to insure this person’s life? Does a buy-sell agreement depend on this policy? What does the latest policy statement show for cash value and surrender value?

What is key person insurance?

Key person insurance is life insurance a business owns on an employee whose work, relationships or know-how the company depends on. The Insurance Information Institute describes it as a way to compensate a business for financial losses caused by a key employee’s death or disability.

The business usually pays the premiums. It also receives the death benefit if the insured dies while the policy is in force. The money helps the company absorb the hit, such as lost revenue, recruiting costs or debt it still must repay.

Both whole life insurance and term life insurance appear in these arrangements. The type matters at departure. A term policy has no cash value to keep, transfer or surrender. A whole life policy does.

Federal law generally leaves life insurance death benefits out of gross income, with exceptions. The IRS states that death benefits are generally excluded, and that interest on proceeds is taxable when the proceeds are held under an agreement to pay interest.

Option one: keep the policy in force

The company can keep the policy. It stays the owner and beneficiary, and it keeps paying premiums after the employee leaves. This path makes sense when the business still has a real reason for the coverage, such as a buy-sell funding need or company debt.

Write that reason down. A policy kept only because nobody made a decision can cost money for years with no clear purpose. Pull the latest statement and confirm the premium amount, the payment period, and any change in premiums or face amount.

Also check for any age-based change. Those changes can raise the cost later. Premiums are a business cash-flow item, so they belong in the company’s budget and tax planning, not only in the owner’s notes.

Option two: transfer the policy to the departing employee

A transfer to the insured employee is one option when the employee leaves on good terms. The company no longer needs the coverage. The employee becomes the owner, pays future premiums and makes later coverage decisions.

The transfer needs careful tax review. Federal law excludes death benefits from income, but it includes exceptions, among them the transfer-for-value rules. A transfer can change the tax result. Review it with the company’s tax adviser before signing anything.

Check the buy-sell agreement first. If the agreement ties to this policy, a transfer may affect how the agreement works. Confirm the transfer is written in both the policy file and the company’s records.

Once the policy moves, the company loses control of it. Make sure the employee understands the premiums they will now carry.

Option three: surrender the policy and understand the cash value

Surrender means the owner asks the insurer to end the policy and pays out its cash surrender value. The policy ends, and the death benefit ends with it.

If an insurance agent recommends the surrender of an annuity or life insurance policy containing a cash value, and does not recommend that the proceeds from the surrender be used to fund or purchase another annuity or life insurance policy, the agent must provide written information relating to that policy before execution of the surrender (Fla. Stat. § 627.4553). See Fla. Stat. § 627.4553. That information includes the estimated surrender charge, possible tax consequences and any forfeited death benefit. The agent must keep a copy and the date it was given. See Fla. Stat. § 627.4553.

Keep guaranteed and non-guaranteed values on separate lines. Guaranteed values come from the contract. Non-guaranteed values depend on the insurer’s experience and can change. Dividends on participating policies are not guaranteed. Any projection of future values is only an illustration, with its own limits.

Policy loans work differently. See Fla. Stat. § 627.458. Check any loan balance before surrender.

Does a personal life insurance policy end when an employee quits?

Coverage an employee holds through an employer’s group plan often ends with employment. Some group plans let the employee continue or convert the coverage. Those terms come from the plan itself, so the employee should read the plan documents.

A key person policy is a different contract. The business owns it. The employee’s departure does not end the company’s policy by itself. The policy stays on the company’s books until the owner acts.

Employees should check their own documents for an end date and any conversion rights. The company and the employee often need separate reviews. One review covers the business-owned policy. Another covers any personal coverage the employee holds.

Keeping the two apart prevents confusion about who owns what. It also makes it clear who pays which premiums.

Questions to settle before the key employee’s last day

Settle these items before the last day, while the company still has the employee’s cooperation.

1. Who will own the policy and be its beneficiary after departure? Is that in the company records and the policy file?
2. Does a buy-sell agreement set a price or process for the departing owner’s interest? Is this policy meant to fund it?
3. What do the premium, cash value and surrender figures show on the latest statement?
4. Did the company get the employee’s written consent before buying the policy? Under Fla. Stat. § 627.404, a business’s right to insure a key person rests on insurable interest, and the signed application is the written consent the insured provides. See Fla. Stat. § 627.404.
5. Have the owners approved the decision in writing? Has the company’s CPA reviewed the tax result?
6. What is the plan for replacing the revenue or knowledge the employee provided?

Talk through your company’s situation

If your company is deciding what to do with a key person policy because a key employee is leaving, a coverage review is a good place to start. NR CPAs & Business Advisors is a Miami CPA firm. Insurance is offered by Nischay Rawal, acting as a licensed insurance agent in Florida, separately from the firm’s accounting practice. Nischay Rawal is paid by commission from the insurer on policies placed, and complete details of that compensation are disclosed in writing, in an engagement letter you sign, before the engagement begins.

Bring the latest policy statement, the employee’s departure date and any buy-sell terms. Then schedule a coverage review with our team.

Frequently asked questions