Key person insurance when key employee leaves is mostly a question of ownership and payment. The policy doesn’t end just because the employee’s job does. A business usually has three paths: keep the policy, transfer it to the former employee, or surrender it for any cash value. The right path depends on who owns the policy, who gets paid, and whether the premiums are current.

This page walks through those choices in plain words. Insurance is offered by Nischay Rawal, a licensed insurance agent, separately from the accounting practice of NR CPAs & Business Advisors.

What Is Key Person Insurance, and Why Does a Departure Raise Questions?

Key person insurance is life insurance a business buys on someone whose work it depends on. The Insurance Information Institute describes it as coverage that compensates the business for financial losses caused by that person’s death or disability.

A policy has three roles. The owner pays the premiums and controls the contract, which is usually the company. The insured is the employee whose life is covered. The beneficiary receives the death benefit, which is also usually the company.

When the employee leaves, the policy stays a contract between the business and the insurer. It doesn’t cancel on its own. That’s why the departure raises questions. The company must decide what the policy still does for it, and whether the cost still makes sense.

Who Owns the Policy, Who Gets Paid, and Who Can Be Insured?

After an employee leaves, the company usually stays the owner and beneficiary. That changes only if the policy is transferred or surrendered. Start by pulling the policy documents, because they set the owner and beneficiary.

Florida law sets a rule for businesses. A business has an insurable interest in a key employee if the employee gives written consent before the insurance is bought. The business can’t retaliate against someone who says no. The Florida insurable interest statute also says the insurable interest “need not exist after the inception date of coverage under the contract.”

Who can be insured at the start depends on underwriting. The insurer looks at the insured’s health and other facts before issuing a policy. Coverage on one employee doesn’t carry over to a replacement. A new key hire needs separate underwriting, so replacement coverage is never automatic.

Keeping the Policy in Force After the Employee Leaves

A company can usually keep the policy by continuing to pay premiums. Keeping it makes sense when a business need still ties to the former employee. Examples include a loan that relied on that person’s role, a planned handoff of duties, or a buy-sell arrangement that still runs.

Use one test. Compare the ongoing premium with the business need. If the need is gone, the premium is a cost with no business purpose. If the need continues, the premium may be worth weighing. That comparison answers the question “is employee life insurance worth it?” It is a comparison, not a promise of any result.

A term policy keeps running only while premiums are paid and the term hasn’t ended. A whole life policy keeps running under its premium and cash value rules.

Premium status matters. Fla. Stat. § 627.453 requires a grace period of at least 30 days for premiums after the first. The policy stays in force during that grace period. The insurer may charge interest of up to 8 percent per year for the days of grace. After that, a missed premium can end the policy, so track the due dates closely.

Transferring the Policy to the Former Employee

The company may transfer ownership to the departing employee. The employee then owns the policy and controls its premiums and beneficiary. This path can fit when the business no longer needs the coverage but the employee wants to keep it.

Federal tax law adds a checkpoint. Under 26 U.S.C. § 101, a transfer for valuable consideration can cap the tax-free part of the death benefit. The cap is an amount that may not exceed the actual value of the consideration plus the premiums and other amounts the buyer later pays. The statute lists exceptions, and those exceptions decide which rule applies.

Estate tax is another checkpoint. Under 26 U.S.C. § 2042, the value of the gross estate includes the amount receivable by the executor as insurance under policies on the decedent’s life, and the amount receivable by other beneficiaries as insurance under such policies with respect to which the decedent possessed at death any incidents of ownership, exercisable alone or in conjunction with any other 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.” An employee who takes ownership may bring the proceeds into their own estate. Review that before the transfer is signed.

The company’s cost basis and the employee’s future premiums are also part of the discussion. Get the price, method, and tax treatment in writing before anyone signs.

Surrendering the Policy or Cashing It Out

A permanent policy may have cash value to collect. A term policy generally has none. Whole life is the usual permanent type. Surrendering a policy ends the death benefit, and surrender charges can reduce the payout.

Florida adds a safeguard. If an agent recommends surrendering a life policy with cash value, and doesn’t recommend using the proceeds to buy another policy, the agent must first give written information. The Florida surrender statute lists items such as the estimated surrender charge, the possibility of tax consequences, and any forfeited death benefit.

Policy loans are another option. The Florida policy loan statute requires life policies to provide that, once the policy has a cash surrender value and while no premium is in default, the insurer will lend up to the policy’s loan value on proper assignment or pledge of the policy, but the policy must also let the insurer defer granting a loan, other than one to pay a premium, for 6 months after you apply. 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.” It doesn’t apply to term policies. The Florida Department of Financial Services guide also covers policy loans and cash value.

Tax rules can change the answer. Under 26 U.S.C. § 7702A, a contract can become a modified endowment contract. For purposes of subsection (a), a contract fails to meet the 7-pay test of this subsection if the accumulated amount paid under the contract at any time during the 1st 7 contract years exceeds the sum of the net level premiums which would have been paid on or before such time if the contract provided for paid-up future benefits after the payment of 7 level annual premiums. The test compares the amount paid in the first seven contract years with the premiums needed for paid-up benefits. Ask the company’s tax preparer to check this before any loan or withdrawal.

Whether the Company Can Still Collect if the Former Employee Dies

The company generally collects only if the policy is in force and its terms support the claim. Two checks come first: insurable interest and premium status.

Insurable interest is judged when the contract is made. Under the Florida insurable interest statute, an insurer may rely on the applicant’s statements about insurable interest. Fla. Stat. § 627.404 reads: “(3) An insurer shall be entitled to rely upon all statements, declarations, and representations made by an applicant for insurance relative to the insurable interest which such applicant has in the insured; and no insurer shall incur any legal liability except as set forth in the policy, by virtue of any untrue statements, declarations, or representations so relied upon in good faith by the insurer.” That holds when it relies on them in good faith. Accurate records from the time the policy was issued matter.

Whether the company can collect also depends on the policy terms, the state law that governs the contract, and the facts of the departure. Review those against the actual documents, not memory. Keep the employment records, policy documents, and premium payment records together. If the policy lapsed for nonpayment before the death, premium status becomes the central question.

Tax, Cash Flow, and Bookkeeping After the Departure

Premiums on a key person policy generally aren’t deductible for the business. Under 26 U.S.C. § 264, no deduction is allowed for premiums on a life policy if the taxpayer is directly or indirectly a beneficiary. So the premium is a cash flow item to plan for, not a write-off.

Federal tax rules set their own exceptions and limits for policies that cover officers, owners and employees, and the key-person definition used for insurable interest appears in IRC § 101(j)(2)(A)(ii). Whether a former employee still fits that definition is a question for the company’s tax preparer.

Employer-owned policies also have reporting. Under 26 U.S.C. § 6039I, an applicable policyholder owning employer-owned life insurance contracts issued after that section’s enactment must file an annual return. The return shows the number of insured employees and whether valid consent was obtained for each one.

Match those records to the policy documents.

Next Step: Reviewing the Policy After a Key Employee Leaves

The most useful first step is gathering the policy facts before deciding anything. Pull together the policy number, the insurer’s name, the owner and beneficiary, the premium schedule and payment status, any cash value statement, the employee’s departure date, and any loan or buy-sell agreement tied to the policy.

Frequently Asked Questions