Key Person Life Insurance: Planning for a Key Employee's Departure

Leaving the company does not, by itself, cancel a Florida key person life insurance policy. The business usually stays the owner unless someone changes the policy. The real decisions are whether to keep, surrender, transfer or sell it, and each choice has tax and cash flow effects. This page explains those choices in plain words.

Insurance is offered by Nischay Rawal, acting as a licensed insurance agent, separately from the accounting practice of NR CPAs & Business Advisors, a Miami CPA firm.

What a Key Person Policy Is and Who Holds It

The employee is the insured.

The Insurance Information Institute describes this coverage as a way to compensate a business for financial losses caused by a key employee’s death or disability.

Three roles matter here: the owner, the beneficiary and the insured. In many business policies, the company holds the first two roles. When the employee leaves, those roles still need to match the contract and any buy-sell or employment agreement. For the full overview, read our key person insurance guide.

What Happens to the Policy When the Employee Leaves?

Leaving the company does not change who owns the policy. Ownership changes only when the policy is transferred, surrendered or sold. Florida law says an insurable interest need not exist after coverage starts. See Fla. Stat. § 627.404.

Premiums still fall due on the policy’s schedule. The policy stays in force during that grace period. The insurer may charge interest on the late premium, not above 8 percent per year. See Fla. Stat. § 627.453. Once that window ends unpaid, the policy can lapse.

Next, pull the contract and any buy-sell or employment agreement. Look for terms on departing employees, transfers and buyouts. Those terms often shape what the business can do next.

What Options Does the Policy Owner Weigh?

The owner usually weighs four paths: keep, surrender, transfer or sell. Each one affects cash flow, tax and planning in its own way.

• Keep: The business keeps paying premiums and stays the owner and beneficiary.
• Surrender: The owner asks the insurer to end the policy and pay its cash surrender value, if any. The death benefit ends with it.
• Transfer: The owner gives the policy to the departing employee or another person. This can be a planned exit step, with tax limits covered below.
• Sell: The owner sells the policy for cash. This raises the transfer-for-value issue in the next section.

Whole life insurance builds cash value, while term life covers a set period. FINRA’s insurance overview describes whole or permanent coverage as lifetime protection with a cash value feature. That feature is one reason surrender deserves a close look.

If an agent recommends surrendering a cash value policy without recommending a replacement, Florida requires written information first. That information includes the estimated surrender charge, possible tax consequences and any forfeited death benefit. See Fla. Stat. § 627.4553. Which path fits depends on the facts.

How Does Transfer-for-Value Change the Tax Result?

A transfer of a policy for value can cap how much of the death benefit stays tax-free. Death proceeds are generally excluded from gross income. The IRS FAQ on life insurance proceeds explains that general rule.

26 U.S.C. § 101 adds a limit for transfers for valuable consideration. Those are the actual value of the consideration and the premiums and other amounts the buyer pays later.

Here is a simple example. A business sells a policy for $50,000 to a buyer with no substantial family, business, or financial relationship with the insured. The buyer later pays $20,000 in premiums. Whether the $70,000 limit applies to a transfer depends on the transfer-for-value rules described above, even if the death benefit is larger.

Confirm the tax treatment with a CPA before you sign any transfer or sale.

Which Transfers Fall Under the Statutory Exceptions?

The statute lists exceptions to the transfer-for-value limit. So the exact transfer matters.

One exit step is moving the policy to the employee who is insured. Whether that fits a statutory exception should be checked before anything is signed.

The statute also defines a “reportable policy sale.” That is an acquisition by a buyer with no substantial family, business or financial relationship with the insured, apart from the policy itself. For that kind of sale, the exceptions in the transfer-for-value rule do not apply, so the limit on tax-free treatment still applies. See 26 U.S.C. § 101.

Buy-sell agreements add another layer. See Fla. Stat. § 627.404.

What Should Florida Businesses Bring to a Coverage Review?

Bring the policy, the contract, any buy-sell agreement and the employee’s current status to a coverage review. The review starts with the facts, not a guess.

• Who is the owner, beneficiary and insured, and do the contract and agreements match?
• Was the employee’s written consent signed before the policy was bought? Under Fla. Stat. § 627.404(6), the signature of the proposed insured, having capacity to contract, on the application for insurance constitutes his or her written consent.
• Are the cash surrender value and death benefit guaranteed or not guaranteed, and which is which?
• What tax or accounting effects follow from keeping, surrendering, transferring or selling?

Insurance is offered by Nischay Rawal, acting as a licensed insurance agent, separately from the accounting practice of NR CPAs & Business Advisors.

Quick answers

Talk Through Your Policy With Our Team

The next step is a coverage review of the specific policy, its owner and beneficiary, and the transfer options. You may be handling this after a partner, manager or key employee has already left. You may not have chosen the policy or its timing.

Nischay Rawal, acting as a licensed insurance agent, handles the policy questions in a coverage review. Our support staff helps with scheduling. The right choice comes from the contract and your tax position, and we’ll work through both with you.

To set up your coverage review, contact NR CPAs & Business Advisors.