Transferring Key Person Life Insurance to the Employee

Short Answer: Yes, a Transfer Is Possible, but Tax Outcomes Depend on the Details

Yes, a business can transfer ownership of a key person life insurance policy to the insured employee. The tax result, however, turns on three things: how the policy changes hands, what it is worth at that moment, and how many premiums the business has paid.

Owners usually ask this question near a milestone. An employee may be retiring, leaving for another company, or moving into a partner role. The business wants to hand over a policy it has paid for over the years. That goal is reasonable, but the handover is also a tax event. Income-tax rules for life insurance and gift-tax rules for transfers can both apply.

This page explains the main rules in plain words. It then lists the questions to settle before any policy changes hands. The result for your company depends on the facts of your own policy and business.

What a Key Person Policy Is and Why Ownership Matters

A key person policy is life insurance a business buys on an employee whose skills, knowledge or relationships matter to company income. The business usually pays the premiums, owns the policy and names itself as beneficiary. If the employee dies, the company receives the death benefit to help absorb the loss.

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. That purpose explains why ownership matters. The policy is a business asset, and its tax treatment follows who owns it and who receives the money.

Ownership also decides who can make policy decisions, such as changing the beneficiary or taking a policy loan. Once the business gives the policy to the employee, the employee controls those choices. For a full overview of key person coverage, see our key person insurance guide.

The Transfer-for-Value Rule and the Exception for the Insured

A transfer for value can limit the tax-free treatment of a life insurance death benefit. The cap equals the actual value of that consideration plus the premiums and other amounts the new owner pays later. See 26 U.S.C. § 101.

Put simply, if the employee pays the business something for the policy, the tax-free part of the death benefit may shrink. The general rule is that amounts paid by reason of the insured’s death are excluded from gross income. The transfer rule limits that exclusion.

The statute also lists exceptions to this cap. Whether a given transfer falls within an exception depends on how it is structured. A transfer to the insured employee is the common case behind this question, so the exact form of the handover matters.

A separate limit applies to employer-owned life insurance contracts. For those contracts, the excluded amount cannot exceed the premiums and other amounts the policyholder paid, unless the notice and consent requirements are met and the amount falls within an exception, such as a payment to the insured’s family member, designated beneficiary, trust, or estate. Many key person policies are owned by the business, so this limit can matter.

How Cash Value and Premiums Paid Affect the Tax Result

Premiums paid and cash value set how much is at stake when a policy changes hands. Term life insurance has no cash value. Whole life insurance can build cash value over time, and the policy statement shows that figure.

For gift tax, federal rules value a policy by reference to what the insurer would charge for a comparable contract. Under 26 C.F.R. § 25.2512-6, a policy that has been in force for some time and on which further premium payments are to be made can be valued approximately by adding the interpolated terminal reserve at the date of the gift to the part of the gross premium last paid before the gift that covers the period after that date, but this method may not be used if, because of the unusual nature of the contract, it is not reasonably close to the policy’s full value. A paid-up policy is valued at the single premium the company would charge for a comparable contract. The regulation’s examples assume no accrued dividends and no outstanding loans, so loans and dividends change the math.

Cash value is a feature of the policy. It is not a promised return or profit for the owner. Where a policy pays dividends, those dividends are not guaranteed. The NAIC Life Insurance Buyer’s Guide explains the difference between term and permanent life insurance and what to ask before buying.

Questions to Settle Before Any Transfer

Settle these questions before any document is signed. They shape both the tax path and the practical result.

• Is the policy term or whole life, and what is its current cash value?
• Is the transfer a gift, a sale, or a buy-out tied to the employee’s departure? If a price is set, what is it?
• Who will own the policy, name the beneficiary and pay future premiums after the transfer?
• Does a buy-sell agreement or other contract control the policy or its ownership?
• Has the insurer been asked about its ownership change forms?
• If the employee or owner lives outside the United States, how will premiums be paid from a foreign account? See premiums from a foreign account.

The gift question has its own rules. Under 26 C.F.R. § 25.2511-1, the gift tax applies to a transfer by way of gift, and the regulation names the assignment of the benefits of an insurance policy as one example. The same regulation also sets out examples of transactions resulting in taxable gifts, and in each case it is assumed that the transfers were not made for an adequate and full consideration in money or money’s worth. A sale made in the ordinary course of business, at arm’s length and without any donative intent, is treated as made for adequate consideration under 26 C.F.R. § 25.2512-8.

For 2026, the annual gift tax exclusion is $19,000 per donee, according to the IRS gift tax FAQs. Executors also use IRS Form 712 with certain estate or gift tax returns to report life insurance amounts.

Other Points That Affect the Decision

Tax rules are only part of the picture. A newer policy may still be in its contestability period. During that time, the insurer can check the application for accuracy. Learn more in our contestability period guide.

The insured amount also matters. It sets the coverage the business carries. See how insurers set the amount.

On the death benefit itself, the IRS life insurance proceeds FAQ states that life insurance death benefits are generally excluded from gross income, while interest on those proceeds is included in gross income if the amount is held under an agreement to pay interest.

Roles on this page are kept separate. Nischay Rawal is a licensed insurance agent, and insurance is offered by the licensed agent, separately from the accounting practice of NR CPAs & Business Advisors. If we discuss a specific policy, we name its insurer. This page quotes no premium.

Talk Through Your Situation Before Any Transfer

If your company is about to hand a key person policy to the employee it covers, timing matters. Cash value, the price and the transfer form all affect the tax result. They should be reviewed together before anything is signed.

Our team can walk through those facts with Nischay Rawal, a licensed insurance agent, in a coverage review. We explain any fee for a coverage review when you call. Contact us to start that conversation before the policy changes hands. Clear planning helps protect your loved ones and the business they depend on.