Who Should Own a Key Person Life Insurance Policy?

Who should own a key person life insurance policy? The answer comes down to three questions: who pays the premium, who collects the benefit, and who can make changes. This guide compares three options: the company, the owner, or an irrevocable trust. It is written for business owners in Florida, including Miami, Fort Lauderdale, West Palm Beach, Orlando, Tampa and Jacksonville. NR CPAs & Business Advisors is a Miami CPA firm. Insurance is offered by Nischay Rawal, a licensed insurance agent, separately from the accounting practice.

What Key Person Life Insurance Is and Who It Fits

Key person life insurance is a policy a business owns on the life of someone whose death would cause it financial harm. That person can be an owner, an executive or a key employee. The Insurance Information Institute states that this coverage compensates a business for financial losses caused by the death or disability of a key employee.

Closely held companies, partnerships, professional practices and family businesses are common fits. These businesses often lean on one or a few people for revenue or daily operations.

The policy can be term or whole life. Ownership is a separate question from who is insured. The owner, the insured person and the beneficiary can be different people or entities. A person with legal capacity who buys a policy on his or her own life may name any beneficiary. But when someone buys a policy on another person’s life, the benefits must be payable to the insured or the insured’s personal representatives, or to any person having, at the time such contract was made, an insurable interest in the insured.

Florida adds a step before purchase. A business entity has an insurable interest in the owners, directors, officers, partners, managers or key employees of the business or of any affiliate or subsidiary if consent is obtained in writing from the key employees or persons before the insurance is purchased (Fla. Stat. § 627.404). The business also may not retaliate against a key employee who refuses consent.

Deciding Who Should Own a Key Person Life Insurance Policy: Company, Owner or Trust

The policy owner decides who pays premiums, who collects the benefit and who can request changes or loans. Each option answers those questions differently.

Company-owned. The company owns the policy, pays the premiums and is the beneficiary. The proceeds go to the company, which can use them to cover lost sales, hire a replacement or pay debts. Under 26 C.F.R. § 20.2042-1, the circumstances in which a corporation’s incidents of ownership are attributable to a decedent through stock ownership are addressed in a separate subparagraph of the regulation.

Owner-owned. The owner holds the policy personally and names a beneficiary, such as a spouse, a family member or a buy-sell partner. Under IRC § 2042, proceeds payable to other beneficiaries count in the owner’s gross estate if the owner held incidents of ownership at death. Estate planning needs to account for that.

Trust-owned. An irrevocable trust owns the policy. A trustee holds the policy and manages it under the trust terms, and premiums are paid with contributions to the trust. The client’s attorney drafts the trust, and its terms decide who can make changes.

What the Policy Covers and How Ownership Changes the Result

The death benefit is paid to the named beneficiary under the policy’s terms when the insured dies. The company decides how to use its share, such as covering lost revenue, recruiting a successor or paying a business debt.

Read the exclusions and limits before you buy. Florida requires a life policy to become incontestable after it has been in force for 2 years from its issue date, with listed exceptions such as nonpayment of premiums (Fla. Stat. § 627.455). Fla. Stat. § 627.455 reads: “Every insurance contract shall provide that the policy shall be incontestable after it has been in force during the lifetime of the insured for a period of 2 years from its date of issue except for nonpayment of premiums and except, at the option of the insurer, as to provisions relative to benefits in event of disability and as to provisions which grant additional insurance specifically against death by accident or accidental means.”

For whole life, ask the insurer to show guaranteed values and non-guaranteed values separately. Non-guaranteed values can change. Treat any illustration as an example, not a promise.

Tax treatment can differ by owner and beneficiary. Under the federal income tax rules, death benefits are generally excluded from gross income. Employer-owned contracts follow special rules, including a limit tied to the premiums paid, which does not apply in listed cases when the notice and consent requirements are met. A business that is an applicable policyholder owning employer-owned life insurance contracts issued after the date of the enactment of this section must file a return under IRC § 6039I. The coverage review covers how these rules apply to your setup.

How the Setup Works: Steps and Timeline

The setup moves in six steps. Underwriting and trust paperwork set the pace.

1. Coverage review. The firm reviews the key person, the company’s financial exposure and the goal for the policy.
2. Pick the owner. The client’s attorney and CPA review any trust or entity documents, and the choice is written down.
3. Underwriting. Expect full underwriting. Health questions are required, and issue may depend on insurability.
4. Review the proposal. Before you sign, check the insurer name, form number, premiums, payment period, limits, exclusions and renewability.
5. Issue and records. Keep the signed written consent from the key person with the policy file.
6. Annual check. Review beneficiaries, ownership records and the premium schedule each year.

Cash Flow, Loans and Ongoing Management

Ownership decides who funds the premium, so write the funding plan down before the first payment. Company cash, owner personal funds and trust contributions each leave different records.

Florida allows a policy loan after the policy has a cash surrender value and while no premium is in default, and the insurer may defer granting a loan for 6 months after application, except for premium payments to the insurer (Fla. Stat. § 627.458). The loan rule does not apply to term policies or to term insurance benefits provided by riders or supplemental policy provisions (Fla. Stat. § 627.458). If the total debt, including interest, equals or exceeds the loan value, the policy can terminate after at least 30 days’ notice.

Florida requires a grace period of at least 30 days for premiums after the first (Fla. Stat. § 627.453). For a natural person 64 years of age or older, on a life insurance contract issued or issued for delivery in this state on or after October 1, 1997 that has been in force for at least 1 year, the contract may not be lapsed for nonpayment of premium unless, after the grace period expires, the insurer has mailed a notification of the impending lapse in coverage to the policyowner and to a secondary addressee designated in writing, at least 21 days before the effective date of the lapse; if the policy’s grace period is more than 51 days, the notice must instead be mailed at least 21 days before the grace period expires (Fla. Stat. § 627.4555). This does not apply to contracts under which premiums are payable monthly or more frequently and are regularly collected by a licensed agent or are paid by credit card or any preauthorized check processing or automatic debit service of a financial institution.

Before replacing or surrendering a policy, ask for written information on surcharges and any forfeited death benefit. Florida requires written information before a surrender, including the estimated surrender charge, the loss of any minimum interest rate guarantees, the possibility of tax consequences, the forfeited death benefit and other forfeited investment performance guarantees, when an agent recommends a surrender and does not recommend that the proceeds be used to fund or purchase another annuity or life insurance policy (Fla. Stat. § 627.4553). Keep transfers, beneficiary changes and consents in one file.

Why Work With NR CPAs & Business Advisors

NR CPAs & Business Advisors is a Miami CPA firm. It helps families, professionals and business owners across the United States choose and buy life insurance, including key person and buy-sell coverage.

The firm pairs a CPA’s view of tax and cash flow with insurance placement by a licensed agent. Nischay Rawal is the responsible agent and acts as a licensed insurance agent. Insurance is offered by the licensed agent, separately from the accounting practice. Support staff, including assistants and office staff, help with the paperwork.

If the firm accepts a commission on a policy, it must disclose that fact to the client in writing (Fla. Stat. § 473.3205). The firm explains its fees and all the variables in writing before work starts.

Indian-American business owners and NRI clients can also review the firm’s NRI life insurance practice area.

Common Questions About Ownership

Most owners first ask who should pay the premium. The answer turns on tax and cash flow.