102-10 Biz Uses of LI and Other Emp Benefits Flashcards
Key employee life insurance
Life insurance applied for, owned by, and payable to the business on the life of key valued employees (usually execs)
Premiums are not tax deductible, and death benefits received by the business are generally income tax-free
Split-dollar life insurance
An arrangement, typically between an employer and an employee, in which there is a sharing of the costs and benefits of the life insurance policy
Two types:
- Collateral assignment method
- Endorsement method
Collateral assignment method
Owner of policy: employee
Tax treatment of policy premiums: nondeductible
Employer’s portion of death proceeds: employer is refunded loan equal to premiums paid
Employee’s portion of death proceeds: remainder to employee’s designated beneficiary
Appropriate for situations when the exec benefiting from the plan is a majority shareholder
Endorsement method
Owner: employer
Tax treatment of policy premiums: nondeductible
Employer’s portion of death proceeds: employer retains a portion equal to its premium outlay
Employee’s portion of death proceeds: remainder to employee’s designated beneficiary
May be appropriate when exec benefiting from plan is not a majority shareholder
Disadvantage of split-dollar ownership form
The employee must pay income taxes each year on the economic benefit derived from the arrangement
Section 162 Executive Bonus Plan
The employer business pays the employee a bonus equal to the premiums due on a personally owned life insurance policy of the employee
Employer then deducts this premium amount as additional compensation to the employee and employee reports the amount as ordinary income
Death Benefit Only (DBO) plan
The employer corporation is the owner and beneficiary of an insurance policy owned on the life of a valued exec
The death benefit paid from the policy (once received by the employer beneficiary) is forwarded to the exec’s heirs in lieu of compensation that was previously deferred
The payments made to the heirs are not generally included in the gross estate for estate tax purposes
Exception: where the exec is greater-than-50% or controlling shareholder
Group Term Life Insurance
GTLI premiums - up to the first $50k of face value paid for by the employer, are income tax-free to the employee
For any amount > $50k, the scheduled premium per $1k of coverage is included in the employee’s compensation (W-2) income
GTLI typically includes a conversion provision to individual permanent life insurance at the employee’s separation from service w/ the sponsoring employer
Group permanent insurance
Policies operate essentially as individual policies with simplified underwriting, group billing, and administrative costs
When an employee leaves/retires, the group policy usually stays in force as an individual policy
The policies of terminates and retired employees are generally treated as a separate class, so only this class pays for any adverse selection
Group carve-out plans
Combine the advantages of group permanent insurance w/ those of GTLI
The employer reduced the amount of GTLI coverage on highly paid employees to no more than $50,000
The remainder of the benefit is then provided by permanent cash value-type life insurance owned by that same employee; however, the employer pays the premium
Because the entire premium is treated as compensation to the employee/exec, the amount is fully deductible by the employer
Life insurance in qualified plans
Life insurance can be provided through a qualified plan if the plan meets the incidental death benefit requirement
A plan must pass 1 or 2 tests to meet this requirement
Under the 25% test, the aggregate premiums paid for a term or universal life insurance policy cannot exceed 25% of the employer’s contributions to the plan
The % limitation is 50% when whole life insurance is used
Under the 2nd test, which applies to defined-benefit plans, the death benefit provided by life insurance cannot be more than 100x the expected monthly benefit to be paid to the employee under the plan
Cafeteria plan
A plan in which employees may, within limits, choose the form of employee benefits from options provided by their employer
Must include a cash option
The plan is most appropriate to implement when the employee benefit needs bath within the employee group
A cafeteria plan that is funded entirely through employee salary reductions (with no employer contribution whatsoever) - known as an FSA
May not be included in the tax-free plan:
- scholarships and fellowships
- educational assistance
- employee discounts
- retirement or nonqualifed plan benefits
Flexible spending account (FSA)
A cafeteria plan consisting of various tax-free benefits that are funded trough salary reductions elected by employees each year
Most appropriate when costs of employee benefit plans, such as health insurance, have increased and the employer must impose additional employee cost sharing
- Deductibles on health insurance policies
- Coinsurance provisions on group health policies
- Dependent care (child care) expenses
Dental insurance
Normally covered on a group basis
Vision insurance
Covers care and treatment for the eyes
