Who Is the Owner and Beneficiary on a Key Person Policy?

Key person insurance is a specialized life insurance policy a business acquires on the life of an individual whose knowledge, work, or overall contribution is valuable to the company. This coverage protects the business from financial consequences that could arise if this individual were to unexpectedly pass away or become incapacitated. The purpose of such a policy is to provide a financial cushion, allowing the business to manage disruption and costs associated with the loss of a team member.

Understanding Key Person Policy Ownership

Ownership of a key person insurance policy typically resides with the business entity itself. The company applies for the policy, becoming the policyholder and assuming all rights and responsibilities. This arrangement differs from personal life insurance, where the insured individual usually owns the policy. The business, as the owner, is responsible for paying all policy premiums.

The owner maintains complete control over the policy, including the ability to make changes, access any accumulated cash value if it is a permanent policy, or even surrender the policy. This control allows the business to manage the policy in alignment with its evolving financial protection needs. A business typically owns such a policy because it is the entity that stands to suffer a direct financial loss if the key person is no longer able to contribute. The key person, while being the insured individual, does not own the policy or pay premiums. However, their written consent is generally required for the business to take out the policy on their life.

Designating Key Person Policy Beneficiaries

The beneficiary on a key person insurance policy is almost always the business itself. This designation ensures that any death benefit proceeds are paid directly to the company, rather than to the key person’s family or estate. The primary role of the beneficiary is to receive the payout upon the insured key person’s passing.

These funds are intended to help the business mitigate the financial impact of losing an individual. The company can use the death benefit for various purposes, such as covering operational losses, finding and training a replacement, or paying off debts. The goal is to provide financial stability and allow the business time to adapt to the absence of the key person. The concept of insurable interest is central to designating the beneficiary. For a key person policy, the business must demonstrate an insurable interest in the life of the insured individual, meaning it would suffer a financial loss if that person died.

Common Ownership and Beneficiary Arrangements

The most common arrangement for key person insurance policies involves the business acting as both the owner and the sole beneficiary. In this standard setup, the company pays the premiums and receives the death benefit directly if the insured key person passes away. This structure directly aligns with the policy’s purpose: to protect the business from financial harm.

This direct alignment is practical because the business is the entity that incurs the financial burden when a key employee is lost. The insurance proceeds then provide the necessary liquidity to navigate this difficult period, covering expenses or lost revenue. While less common, other arrangements may exist depending on specific business needs or creditor requirements. For instance, a policy might be used as collateral for a business loan, where a financial institution is assigned a portion of the death benefit. In such cases, the business typically remains the owner, but the beneficiary designation might be temporarily altered or split to satisfy the lender’s security interest.

Financial Implications of Policy Roles

The financial implications of key person policies primarily revolve around the tax treatment of premiums and death benefits. For the policy owner, typically the business, premiums paid for key person insurance are generally not tax-deductible as a business expense. The Internal Revenue Service (IRS) generally does not allow deductions for life insurance premiums if the business is the direct or indirect beneficiary of the policy, as outlined in IRS Section 264.

The rationale for non-deductibility is that the death benefit proceeds received by the business are usually tax-free. If the policy is a permanent life insurance type, any cash value growth within the policy is generally tax-deferred, but accessing these funds through withdrawals or loans may have tax consequences. For the beneficiary, the death benefit proceeds received from a key person policy are generally excluded from the business’s taxable income. This tax-free treatment is consistent with IRS Code Section 101. However, for policies issued after August 17, 2006, specific requirements under IRS Section 101 must be met for the death benefit to remain tax-free, including proper notice and written consent from the insured employee. Failure to comply with these requirements can result in the death benefit becoming taxable income to the extent it exceeds the premiums paid.