When a Key Person Leaves Your Company, Your Key Person Policy Still Needs a Plan

A key person policy after insured leaves company stays in force only while someone keeps it going. When an owner retires or exits, the business has four real choices: keep the policy, transfer it to the insured, surrender it, or keep paying premiums through the change. Each path changes ownership, taxes and cash in different ways. This page explains each one in plain words for Florida business owners and for owners who live or work abroad.

Why a Key Person Policy Changes When the Owner Leaves

A key person policy usually stays in place after an owner leaves, but the company must decide who controls it next.

Key person life insurance is a policy a business buys on a key employee, officer or owner. The Insurance Information Institute describes it as compensation for a business’s financial losses from a key employee’s death or disability. The company usually owns the policy, pays the premiums and names itself as beneficiary. The payout comes on the insured’s death, not on retirement.

That setup creates three roles: owner, insured and beneficiary. When the insured steps away, the question is who owns the policy and who pays. Retirement does not end coverage by itself. The policy stays in force only while premiums are paid and the policy terms are met.

Common triggers for review include retirement, a share sale, a buyout, a move out of the company or a change in the insured’s health. Review the policy before the date arrives, not after.

Option 1: Keep the Policy in the Company

The company can keep the policy, keep paying premiums and remain the beneficiary.

This fits only when the company still has a financial stake in the insured’s life. Ask whether the business would still lose money if that person died. If yes, keeping the policy may make sense.

Taxes matter here. Under 26 U.S.C. § 264, no deduction is allowed for premiums on a life insurance policy if the taxpayer is directly or indirectly a beneficiary. A company that names itself as beneficiary generally cannot deduct those premiums. Its exact position needs a tax review.

Florida law also lets the insurable interest end after coverage starts. Under Fla. Stat. § 627.404, the insurable interest need not exist after the inception date of coverage. A new policy on that person would need written consent first.

Option 2: Transfer the Policy to the Insured at Fair Market Value

The company can transfer the policy to the departing owner, usually for a price tied to the policy’s value.

A transfer for value is a sale of the policy. Under 26 U.S.C. § 101, death benefits are generally excluded from income, but a transfer for value can change that treatment. Whether an exception applies depends on the facts, so review the transfer before anyone signs.

Value is the harder question. The insurer’s cash surrender value is one number, but federal estate tax rules use a different method. Under 26 C.F.R. § 20.2031-8, a policy on another person’s life is valued through sales of comparable contracts, but when the policy has been in force for some time and premiums are still due, the value may be approximated by the interpolated terminal reserve plus the unused part of the last premium paid. When no further premiums are due, the value is the single premium the company would charge for that coverage at the insured’s age.

The insured then takes on ownership, future premiums and the policy’s terms. Ask for guaranteed and non-guaranteed values to be shown separately. If the insured still holds ownership at death, the proceeds can count in the estate, as 26 U.S.C. § 2042 explains. The company’s own gain or loss needs a separate tax review.

Option 3: Surrender the Policy

Surrender ends the policy, and the company receives the insurer’s cash surrender value, if any.

Florida defines a voluntary surrender as the owner’s request to end a policy before maturity, in exchange for its current cash surrender value, and it excludes transactions such as maturity, policy loans and lapse for nonpayment of premium. Under Fla. Stat. § 627.4553, an agent who recommends surrender, without recommending that the proceeds fund or purchase another annuity or life insurance policy, must first give written information. That includes surrender charges, possible tax consequences and any forfeited death benefit.

Surrender is permanent. The coverage ends, and the insured cannot restore that same policy later.

Surrender is not the same as borrowing. Under Fla. Stat. § 627.458, a loan can be advanced once the policy has cash surrender value and no premium is in default. 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.” That section does not apply to term policies or to term insurance benefits provided by riders or supplemental policy provisions. For loan details, see our borrowing against key person policy cash value guide.

Option 4: Continue Premiums Through the Transition

The company can keep paying premiums during a phased exit so the policy stays in force.

This often fits a gradual change, such as a phased retirement or a share sale spread over several years. The plan should name who pays each premium and which entity owns the policy during that time.

Lapse is the main risk. Under Fla. Stat. § 627.453, every insurance contract must give a grace period of at least 30 days for any premium after the first. The policy stays in force during that grace period. After it passes unpaid, the policy can lapse. Restoring a lapsed policy may require new health information from the insured.

Changing the payer or owner needs paperwork too. Record the change with the insurer so the policy matches what the business actually does. Put the continuation plan in writing before the change takes effect.

How a Buy-Sell Agreement Can Change the Answer

A buy-sell agreement can decide which of the four options applies when an owner leaves.

Many key person policies fund a buy-sell agreement. The agreement sets who buys the departing owner’s interest and at what price. Three common structures appear:

• Cross-purchase: owners buy each other’s shares and own policies on each other.
• Entity purchase: the company buys the departing owner’s shares and owns the policies.
• Wait-and-see: the decision waits until the trigger event, and the agreement sets the rules then.

Each structure points the policy in a different direction. A valuation formula or funding term may control whether the policy is transferred, surrendered or kept. Florida law also gives an individual party to a contract for the purchase or sale of an interest in any business entity an insurable interest in the life of each other party to such contract, for the purpose of that contract only, under Fla. Stat. § 627.404. Have the company’s attorney review the agreement alongside the insurance decision.

Next Step: Bring Your Exit Situation to a Coverage Review

A coverage review can sort out which of the four options fits a company-owned policy on a departing owner.

Picture a company that owns a policy on an owner who is retiring, selling shares or moving abroad. Premiums are still due, and the buy-sell agreement may or may not mention the policy. Gather these items before the review:

• Policy form number and insurer
• Owner and beneficiary designations
• Current cash and surrender values
• Premium history
• Buy-sell terms

Insurance is offered by Nischay Rawal, a licensed insurance agent, separately from the firm’s accounting practice. Any commission on an insurance sale is disclosed in writing before the engagement. Fees are set out in writing before any engagement begins.

If your company holds a policy on an owner who is retiring or selling shares, contact our team to set up a coverage review.