Plan for leadership changes before they happen

A succession plan does not supply cash when a key person dies. It sets who leads the business and who owns each share. Key person insurance is a separate policy that can put cash into the business. If you already have a plan, you may still wonder whether a key person insurance succession plan needs a second tool. This page explains where the two tools differ and how they fit together. NR CPAs & Business Advisors is a Miami CPA firm that serves Florida business owners, including owners in Miami, Fort Lauderdale, West Palm Beach, Orlando, Tampa and Jacksonville, and Indian-American business owners.

What a Succession Plan Does and What It Does Not Do

A succession plan is a set of decisions and documents. It names who will lead, who will own what share, and how ownership moves when that changes.

The plan sets terms. It does not create money. A signed plan does not place cash in the business account on the day a key person dies.

Key person insurance is a different tool. The business typically owns the policy, pays the premiums, and is the beneficiary. The Insurance Information Institute describes key person coverage as compensation to a business for financial losses caused by the death or disability of a key employee.

A buy-sell agreement is a third piece. It is a contract among owners about what happens to an ownership interest. It may be funded with life insurance, or it may not be. Read it together with the succession plan and any policy, not on its own.

Owners often assume the plan covers everything. The plan answers who and how. Cash is a separate question.

What a Succession Plan Typically Leaves Unpaid in Year One

A succession plan usually leaves the first year’s bills unfunded. Those bills keep their schedule even when leadership changes.

Expect four main costs:

• Replacement pay. An interim manager or a newly promoted employee needs salary and benefits while learning the role.
• Lost revenue. Clients or referral sources tied to the person who died may slow down or leave.
• Fixed obligations. Loan payments, lease payments and payroll fall due on the same dates, no matter who is in charge.
• Customer transition costs. Retention efforts, re-bidding, and temporary staff or outside help all cost money.

The plan may also show a transfer date. That date is not the same as the day cash starts to move. Owners who treat the two as one can miss the gap. The gap is easy to overlook on paper.

Why the First Twelve Months Create the Cash-Flow Gap

The first twelve months are where the cash gap usually shows up. A death can compress a planned, gradual handover into a few weeks.

Access to money can also slow down. Estate settlement and business valuation take time. Federal valuation rules define the fair market value of a decedent’s interest in a business, whether a partnership or a proprietorship, as the net amount a willing buyer would pay a willing seller. Those rules call for a fair appraisal of the business’s assets, including goodwill, and its demonstrated earning capacity.

So the owner’s share or sale proceeds may not be reachable quickly. A business can have strong long-term value and still run short of cash in those months.

The practical question is simple. How much cash will the business need in the first twelve months? And how much can it reach quickly without selling assets at a discount?

How Key Person Insurance Fills That Gap

Key person insurance pays cash to the business, which can use it for first-year needs. The business owns the policy, pays the premiums, and receives the proceeds as beneficiary.

How the money gets used is a management decision. The proceeds can help cover replacement pay, debt payments or payroll. The business makes that choice.

Tax treatment has two parts. The IRS says life insurance death benefits are generally excluded from gross income. Interest paid on those proceeds is taxable.

Premiums follow a different rule. Under IRC § 264, a deduction for life insurance premiums is generally not allowed when the taxpayer is a beneficiary of the policy. That often applies to key person coverage the business owns for its own benefit.

Term life insurance and whole life insurance are both used in key person planning. Each has different premium, duration and cash-value features. Review the insurer, the policy form number and the limits before deciding.

Key person coverage pays the business, not the family directly. It does not replace personal life insurance.

Nischay Rawal, a licensed insurance agent, offers insurance matters on this page. Insurance is offered by the licensed agent, separately from the accounting practice.

How a Succession Plan and Key Person Coverage Work Together

A key person insurance succession plan should be read as two tools, not one. The succession plan says who takes over. Key person coverage can supply cash while that change happens.

Where a buy-sell agreement is funded with life insurance, the insurance supports the purchase price. Key person coverage supports operating cash flow. Read both together with current ownership percentages.

A successor who is not yet ready may still need the business to carry coverage through the transition period.

Florida law sets consent rules for these policies. Under Fla. Stat. § 627.404, a business may insure an owner, officer, partner, manager or key person. The business must have that person’s written consent before buying the insurance. The business may not retaliate against a key employee or key person who refuses to consent to insurance on that person’s life.

The same statute lets an individual party to a contract to buy or sell a business interest insure each other party’s life. That right applies to that contract only.

Plans written several years ago may not reflect current revenue, debt, payroll or ownership percentages. A periodic review helps keep the pieces aligned.

The CPA’s Role in Checking the Cash-Flow Gap

A CPA can build a first-year cash projection from the owner’s own records. The projection shows whether the gap is real and how large it could be.

The projection can list:

• Replacement compensation
• Fixed obligations, such as debt, lease and payroll
• Expected revenue loss
• Cash available without selling assets

It can also show how premiums change annual cash flow. It can show how the books would record the policy and any proceeds.

The projection is only as good as its inputs. Owners should update it when revenue, debt or ownership changes.

The analysis does not promise any result. It reports what the numbers show, and the owner decides what to do next.

Accounting and tax services come from the CPA firm. Insurance is offered by the licensed agent, separately from that practice.

Bring Your Succession Plan to a Coverage Review

Picture an owner whose written plan names a successor. That owner’s cash reserves would be the first source for payroll and loan payments after a loss. That gap is where a coverage review starts.

Contact NR CPAs & Business Advisors to arrange a coverage review of your succession plan and first-year cash needs. The review makes no promise of any result. Nischay Rawal is the responsible licensed insurance agent for insurance matters on this page. Any fee for the coverage review is disclosed in writing before we begin.

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