Business Uses of Insurance and Annuities Flashcards
Buy-sell agreements: 2 types
- arrangement for the sale of individual’s interest in a business due to death or disability
1. Stock redemption (entity purchase)
2. Cross-purchase (stockholder agreement)
Stock redemption (Entity purchase)
- buy-sell agreement
- corporation buys stockholder’s interest using the LI proceeds
- better when there’s multiple owners
- corportaion is owner and beneficiary of the policy
- premiums are nondeductible
- DB is tax free to corporation
- other owners basis remain unchanged
- creditors can be attached
Cross-purchase (stockholder agreement)
- buy-sell agreement
- stockholder buys other stockholder’s interest with LI proceeds
- better with less owners
- LI purchased by each shareholder for each others lives
- premiums nondeductible
- DB tax free to individual beneficiary
- owner gets step up in basis
- deceased estate gets step up basis
- creditors can be attached
Benefits of a buy-sell agreement
- guarantees a market for the business interest
- provides liquidity for the payment of death taxes and other estate settlement costs of the deceased owner
- helps establish the estate tax value of the decedent’s business interest
- enables the business to continue in the hands of the remaining owners
- makes a business a better credit risk
Buy-sell step-up basis
Stock purchase
- company owns policy and receives benefits
- surviving individual basis remains unchanged
- deceased gets step up in basis
Cross-purchase
- individual owns the policy
- individual gets step up in basis
- deceased gets step up in basis
Disability buy-sell vs LI buy-sell
Disability
- deceased pays CG above basis
- family gets no benefits
LI
- family gets benefits
- deceased gets step up in basis
- proceeds with step up now in estate
Buy- sell agreement and transfer for value exposures
- individual can purchase own policy from corporation to avoid transfer for value
Key employee life insurance
- acquired to protect an employer against economic loss from the death of a valued employee
- business should be the owner and beneficiary to the policy
- premiums are nondeductible
- DB tax free
Split-dollar plan
- arrangement under which an employer and an executive share costs and benefits of a life insurance policy
1. Endorsement method
2. Collateral assignment method
The endorsement method
- employer owns policy and pays premiums
- employee’s beneficiary is named to receive employees share of DB proceeds
- employer retains CV or premiums paid if surrendered
The collateral assignment method
- insured employee is policyowner
- corporation lends employee the corporation’s share of premium
- corporation receives premiums paid at death or termination of policy
- employee gets CV or beneficiary gets DB
Business overhead expense insurance (BOE)
- policies cover the ongoing costs of operating a business while the business owner is totally disabled
- actual expenses are reimbursed (not salary)
- usually for 1 or 2 years
BOE - Sole proprietor
- premiums are deductible as a business expense
- proceeds are taxable
BOE - Corporations (Reg. and S)
- cannot deduct premiums
- can receive income tax free
Annuities description and types
- periodic payment from an account maintained by a life insurance company beginning at a specific or contingent date and continuing for a fixed period or for the duration of a life
Types - Immediate, fixed, variable
- accumulation, annuitization
- life, period certain, joint and survivor
Pure life annuity
Aka. straight life
- provides periodic benefit payments as long as the annuitant lives with the payments ceasing upon death of annuitant
Advantages
- guaranteed stream of income for life
- no value left at death subject to estate tax
- highest payout among other types
Disadvantages
- fixed payment (no inflation)
- annuitant cannot commute benefit: ask for principle instead
- can die before return of principle is met
- loses most purchasing power in 30 or 40 years
Period certain annuity
- certain number of guaranteed payments regardless if annuitant dies
- 5,10, 15,20 year policies
- the longer the guarantee, the lower the payout
Refund annuity
- upon death of annuitant, policy will pay to their estate or a beneficiary a lump sum that is the difference of purchase price of annuity and sum of monthly payments already distribute d
- tax free up to basis
Joint and survivor (not joint life)
- annuity payout computed based on two lives
- payments until both people die
Single premium deferred annuity (SPDA)
- annuity is purchased with a single premium rather than periodic payments
- earnings accumulate tax deferred until distributed
Variable annuity
-premiums invested in portfolio with MF life investments
- both insurance and security license needed to sell this
Suitability for variable annuity
- high risk tolerance
- “attempt to cope with inflation”
- “keep up with market conditions”
Qualified Longevity Annuity Contract (QLAC)
- deferred fix annuity funded from an IRA ro qualified retirement plan
- designed to keep client from outliving retirement savings
- provide guaranteed monthly income
- longer you defer start date, higher premiums will be
- can defer income by reducing RMDs
Taxation of annuities
- investment income is not taxed until distributed
Annuities - taxation of periodic distributions
- deferred payout: not taxed until payments begin
- annuity exclusion ratio used to determine taxability of periodic payment
Annuity exclusion ratio
- earnings taxed at ordinary income
- return of basis portion is non-taxable
mo. payment X life expectancy in mo. = expected return
investment / expected return = exclusion ratio
exclusion ratio X monthly payment = amount excluded from taxes
Annuity - Loss deduction
- only claimed if loss is incurred in connection with taxpayers trade or business, or for transaction entered into for profit
- ordinary loss
Annuity - taxation and withdrawals
- LIFO (contracts after Aug. q3 1982)
- withdrawal taxable if CV exceeds investment
- withdrawals prior to 59 1/2 subject to 10% penalty
