LIFE INSURANCE PLANS FOR BUSINESSES

  • Life insurance is a powerful and flexible financial instrument with many useful applications for companies of all sizes.

  • For business owners, it can help facilitate business continuity, protecting the company against the loss of a key person, providing liquidity to fund a succession plan, and ensuring the company can continue to thrive well into the future.

  • Used as a benefit, life insurance can help employers recruit, retain, and reward employees and executives.

Each organozatonal structure (C-Corporation, S-Corporatopm, LLC, etc.) is subject to a unique set of rules affecting life insurance planning.  Not every typoe described on our website is appropriate for each organizational structure

KEY PERSON LIFE INSURANCE

  • Key person life insurance is coverage taken out by an organization to protect the business against financial loss in the event of a key person’s death.

  • The key person may be an owner, an executive, or anyone else whose death could potentially create a financial hardship for the company.

  • A key person insurance policy is owned and paid for by the company, insures the key person, and names the company as the beneficiary.

Special Note for C-Corporations:  Life insurance death benefits paid to a C-Corporation may impact the calculations used to determine the Alternative Minimum Tax.  C-Corporations should consult with tax and or legal advisors before implementing a Key Person insurance plan.

BUY-SELL LIFE INSURANCE

  • A buy-sell agreement ensures that surviving owners of a business have the right to purchase the interest of any owner when an owner dies.

  • The buy-sell agreement also guarantees that the deceased’s beneficiaries are fairly compensated for a business interest they inherit.

  • Life insurance is often used in conjunction with a buy-sell agreement, as it provides liquidity to fund the succession plan exactly when it is needed – upon the death of an owner.

  • Buy-sell life insurance plans take two primary forms:  Cross-Purchase, where each business owner purchases a policy on every other business owner and Entity (Stock Redemption), where the organization purchases a policy on each owner.

GROUP LIFE INSURANCE

  • Group life insurance is used as a benefit for the employees of a company.  In this type of plan, each eligible employee is covered under a master contract at premium rates that are based on the age and gender of the insured.

  • Group life insurance plans may be completely employer paid or may have a contributory element where each insured picks up some or all of the premium.

  • This type of insurance usually terminates when the employee leaves the company.  However, some plans allow employees to convert coverage to an individual life insurance policy when they leave the company.

Employees participating in a Section 79 plan offered by a sponsoring corporation may receive up to $50,000 in group term life insurance at no cost, if the plan is non-discriminatory.  The value of any portion of life insurance benefits in excess of $50,000 will be taxable to the employee as W-2 income, determined by using the IRS published Table I rates.

SECTION 162 PLAN

  • Often called “Executive Bonus Plans,” Section 162 plans are a simple way to reward top executives.  Under this type of plan, an executive purchases a permanent life insurance policy on his or her life.  The employer bonuses the employee the premium, which is usually taxable income to the employee and tax-deductible to the employer.

  • The employee controls the policy, including the death benefit and the cash value, which accumulates tax-free until it is withdrawn. 

  • In some cases, a “restrictive endorsement” is used, which limits the employee’s access to the policy cash value until a qualifying event occurs, such as the attainment of a certain age or years of service, a disability, or normal retirement.  This serves as a type of “golden handcuffs,” helping employers retain top employees.

  • In a deferred compensation plan, an executive defers a portion of his or her current compensation until retirement.

  • These plans may discriminate as to which employees are eligible to participate, and are often limited to only a small group of top executives.

  • Under a properly designed plan, no income taxes are incurred by the participant until the money is received.  However, an employer may not deduct any amounts paid to plan participants until funds are actually distributed.

  • Often, life insurance policies are used as an informal vehicle for holding and growing the deferred funds.

Deferrals made after December 31st, 2004 for most employer sponsored deferred compensation plans are subject to compliance with Internal Revenue Code (IRC) Section 409A.  Deferrals made under plans that are materially modified after this date will also be subject to 409A.

 

Non-Qualified Deferred Compensation Plans are considered pension plans for purposes of the Employee Retirement Income Security Act of 1974 (ERISA).  Pension plans must satisfy all five parts of Title I and ERISA, unless the plan is limited to the employer’s “top-hat” group as defined by the Department of Labor, and the plan is unfunded.

 

Special Notice to Owners of Pass Through Entities:  The tax effectiveness of this strategy may be muted because of income and expense “flow through.”  Owners or Pass Through Entities should consult with tax and legal advisors before implementing a Deferred Compensation Plan.

DEFERRED COMPENSATION PLAN

SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

  • In a Supplemental Executive Retirement Plan (SERP), the employer provides funding for a defined benefit or defined contribution plan for a select group of employees.

  • A SERP provides for a series of payments to be made to the executive at retirement or at some other predetermined event.

  • These plans also often promise to pay the executive’s spouse a benefit if the executive dies prior to retiring. 

  • SERP benefits are often informally funded by life insurance.

SPLIT DOLLAR LIFE INSURANCE

  • Split dollar life insurance involves the purchase of life insurance where the ownership of the policy cash value and death benefit is divided.

  • The executive owns a portion of each, and the employer, which typically pays all or most of the premium, owns the remainder.

  • This type of insurance plan is often used when a company wishes to provide lifetime protection for an employee while retaining the ability to obtain cost recovery for its policy contributions.

Under IRS Notice 2002-8, all split dollar transactions will be classified either as Economic Benefit Regime Dollar or 7872 Loan Regime split dollar.  Split dollar arrangements will use either the collateral assignment or the endorsement split dollar method.

 

Special Notice to Executives of Publicly Owned Corporations:  The Sarbanes-Oxley Act of 2002 contains a broad prohibition on loans to executives of publicly owned corporations.  Sarbanes-Oxley has been interpreted to apply to both collateral assignment and endorsement split dollar arrangements.  Under the Act, the premiums paid by an employer for a policy owned by an executive may be considered prohibited personal loans.  Sarbanes is enforced by the Securities and Exchange Commission. 

 

Executives in public corporations should consult with professional tax and legal advisors before entering into any split dollar agreement.

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