Key Person Life Insurance: How the Accounting Entry Is Recorded

A key person life insurance accounting entry depends on who owns the policy and what kind of policy it is. In short, a term policy’s premium is usually an expense spread over the coverage period. A permanent policy’s premium is split between an asset, the cash surrender value, and an insurance cost expense. The death benefit is recorded only when it’s paid. The exact entries depend on the accounting framework the company follows and on the policy’s contract terms. So the examples below are illustrative, not a rule for every company.

Start with the ownership facts: who owns, pays and collects

Ledger treatment starts with three roles. The company is the policy owner, the company pays the premium, and the company is the beneficiary. Key person coverage is built around an officer or key employee whose death or disability would cost the business money. The Insurance Information Institute explains that this coverage compensates a business for those financial losses.

When the company holds all three roles, the company’s cash and the company’s asset are on the books. A personal policy that the insured owns and pays for is different. Premiums the insured pays personally do not run through the company’s ledger. Every entry in this article assumes the company holds all three roles. Check any entry against the company’s own accounting framework and the policy documents before you post it.

Plain-language terms every bookkeeper needs

Start with the core words. The insured is the person whose life is covered. The policy owner controls the contract. The beneficiary receives the death benefit when the insured dies. The premium is the amount paid to keep the policy in force.

Cash surrender value is the amount the insurer would pay if the policy were surrendered. Only permanent policies with cash value have it. A term policy has none. The Florida Department of Financial Services guide covers cash value and policy loans in plain language.

Track guaranteed and non-guaranteed values in separate columns. Guaranteed values are promised in the contract. Dividends, where a policy pays them, are not guaranteed. Mixing the two in one number makes later reconciliation hard. The NAIC Life Insurance Buyer’s Guide explains the difference between term and permanent coverage.

Recording premiums on a term key person policy

A term policy’s premium is usually an expense over the coverage period. Until that period runs, the unused part may sit as a prepaid asset. Which treatment applies depends on when the premium is paid and the framework the company uses.

Here is an illustration. The company pays a $6,000 annual premium in January for a one-year term policy.

• Debit Prepaid insurance $6,000; credit Cash $6,000.
• Each month, debit Insurance expense $500; credit Prepaid insurance $500.

The tax result can differ from the book result. Under IRC section 264(a)(1), premiums on a life policy are generally not deductible when the taxpayer is a beneficiary. Track the gap between the book expense and the non-deductible premium in the tax workpapers, so the return reconciles to the books.

Recording premiums and cash value on a permanent key person policy

A key person life insurance accounting entry for a permanent policy splits each premium into two parts. Part builds cash surrender value, which is an asset. The rest pays the cost of insurance, which is an expense. The insurer’s annual statement drives the split, so use that statement rather than estimates.

Here is an illustration. The company pays a $20,000 annual premium. The statement shows $12,000 added to cash surrender value and $8,000 for cost of insurance and charges.

• Debit Cash surrender value of life insurance $12,000; debit Insurance expense $8,000; credit Cash $20,000.

If the statement shows a dividend, record it as the insurer reports it. Label it as not guaranteed.

Policy loans need their own entry. Suppose the company borrows $30,000 against the policy. Debit Cash $30,000 and credit Policy loan payable $30,000. The loan does not reduce the net cash surrender value, because the IRC section 7702 net surrender value is determined without regard to any policy loan. Loan interest is a separate expense line.

Keep cash surrender value and death benefit separate. Netting them without a framework reason hides the real balances. Also note that under IRC section 7702, a contract counts as life insurance for tax purposes only if it meets either the cash value accumulation test or the guideline premium requirements together with the cash value corridor.

Recording the death benefit and the gain on proceeds

When the insured dies, the company receives the death benefit. It removes the policy’s cash surrender value from the books. The difference is recorded as a gain.

Here is an illustration. The death benefit is $500,000, and the carried cash surrender value is $180,000.

• Debit Cash $500,000; credit Cash surrender value of life insurance $180,000; credit Gain on life insurance proceeds $320,000.

How the gain appears on the income statement depends on the framework. For federal tax, amounts paid because of the insured’s death are generally excluded from gross income under IRC section 101(a). Employer-owned contracts are subject to a limit on the tax exclusion under IRC section 101(j): the exclusion cannot exceed the premiums and other amounts the policyholder paid for the contract, unless the notice and consent requirements are met and an exception applies. The company must also file a return under IRC section 6039I that reports its employer-owned contracts issued after the date of enactment of this section. Confirm these points with your CPA before you post the entry.

Balance sheet and income statement presentation

A permanent policy’s cash surrender value sits on the balance sheet as an asset. A term policy’s prepaid premium, if any, sits as a current asset until the coverage period runs out. Keep the two lines apart so a reviewer can trace each one to its source.

On the income statement, expect three kinds of lines. Insurance expense covers term premiums and the cost of insurance. Interest expense covers any policy loan. A gain on life insurance proceeds can appear when a death benefit is paid, because amounts received under a life insurance contract by reason of the insured’s death are generally excluded from gross income under IRC § 101, except as otherwise provided in paragraphs (2) and (3), subsection (d), subsection (f), and subsection (j). Label each line clearly so it matches the insurer’s statement.

Tax differences belong in the workpapers. The non-deductible premium creates a book-tax difference that must be tracked. Recording it in the workpapers lets taxable income and book income reconcile from year to year.

Why the accounting framework decides the final entries

The key person life insurance accounting entry depends on the framework the company follows. That might be U.S. GAAP, a tax-basis method or another approved method. It also depends on the policy’s contract terms. Two companies with the same policy can book it differently and both be working correctly under their own frameworks.

Keep three items ready before you post the entries: the insurer’s annual statement, the policy form, and your chart of accounts. Nischay Rawal is the licensed agent responsible for this page. Insurance is offered by the licensed agent, separately from the accounting practice of NR CPAs & Business Advisors, a Miami CPA firm. Florida law requires a person to be currently licensed and appointed before acting as an insurance agent, under Fla. Stat. 626.112.

If your company has just bought a key person policy, or the insurer’s statement doesn’t match your ledger, you don’t have to sort it out alone. Reach out through our contact page to set up a coverage review.