Business Uses of Life Insurance Flashcards
What are 2 types of Insured Buy-Sell Agreements?
An agreement to buy a business owner’s interest upon the owner’s death or permanent disability are common with small businesses such as partnerships or close corporations; enables the business to continue to operate after an owner’s death or total disability.
While a buy-sell agreement creates an obligation for the sale and purchase of a deceased owner’s share of the business, it does not provide the funding; life insurance is the ideal product for that.
The two types of buy-sell agreements are:
- cross-purchase plans (life insurance on other partners)
- entity plans (life insurance on owners used to buyout owners shares and pays out to the their personal estate)
Under either type of buy-sell agreement, the deceased’s business interest is bought from his or her heirs.
List 4 characteristics of Cross-Purchase Buy-Sell Agreements
- partners or shareholders agree to buy the interest of the other(s) in the event the individual(s) dies or withdraws from the business.
- The business itself is not involved in the cross-purchase agreement.
- survivors use the money to buy the deceased’s interest in the business.
- the cross-purchase approach makes more sense when there are just a few partners or owners involved.
When there are more than a few parties involved, an entity plan may be more appropriate.
How is a Entity Buy-Sell Agreement different from a Cross-Purchase agreement?
What is a close corporation?
The buy-out agreement for a close corporation is also called a ___________________ agreement
- In contrast to a cross-purchase plan, an entity plan is one in which the business itself is a party to the agreement.
- the business buys the deceased partner’s or shareholder’s interest in the business
- the business buys, owns, and pays the premiums for life insurance policies on the life of each owner.
- When an owner dies, the policy’s proceeds are paid to the business. The business then uses this money to buy ownership share from the deceased’s heirs or estate.
if the business is a close corporation (A close corporation is generally a smaller corporation that elects close corporation status and is therefore entitled to operate without the strict formalities normally required in the operation of standard corporations), the buy-out agreement is also called a stock redemption agreement
5 characteristics of Key Person Insurance
Under a key person (or key employee) insurance plan, a business applies for, owns, and is the beneficiary of the policy covering the life of a key employee.
- Note that key person life insurance is not a type of policy but a use for life insurance.
- Upon the key employee’s death, the business receives the policy death benefit.
- The key employee has no ownership rights to a life insurance policy that is used for key person coverage.
- Key person life insurance also serves as evidence to any creditors that the business can continue despite the key person loss.
- If a key employee ends his or her employment with the employer, the employer can continue the policy in force.
However, many employers choose to:
- sell the policy to the insured for an amount equal to its cash value;
- surrender the policy and end the insurance; or
- change insureds, if allowed by the insurance company and applicable state law (for this to be done, the policy must include a change of insured provision).
4 characteristics of an Executive Bonus Plan
- The employer can deduct the premium payments as compensation paid to an employee.
- The executive must include premium payment as income to him or her.
- Because the executive owns the life insurance policy, he or she can choose the beneficiary.
- In addition, he or she can enjoy all of the other policy ownership rights.
Describe a Nonqualified Retirement Plans
What are the 2 most common types of nonqualifed plans?
A nonqualified retirement plan is any arrangement in which an employer offers a benefit to a select employee (or group of employees), usually executives, that is not offered to all employees.
Because these plans discriminate in who is covered, they do not qualify for favorable tax treatment afforded qualified retirement plans, such as 401(k) and pension plans.
The two most common types of nonqualified plans are:
- the deferred compensation plan and
- the Supplemental Executive Retirement Plan (SERP).
What is a Deferred Compensation Plan and who receives the death benefit?
a nonqualified benefit plan under which an employee, normally a senior executive, agrees to defer a portion of his or her salary or some element of his or her compensation until a future date (typically retirement).
Or, if the executive dies before retirement, the employer receives the death benefit and may pay compensation to the deceased executive’s survivors (in accordance with the plan) by using the policy’s death benefit.
Supplemental Executive Retirement Plan (SERP) is sometimes called a …
List 5 characteristics
Name 2 typical conditions placed on the executive in order to receive SERP benefits.
Also known as “golden handcuffs”
- a SERP is funded entirely by the employer _(_does not involve deferred compensation.
- the executive does not actually defer any compensation.
- the employer agrees to continue paying a portion of the employee’s salary for a limited period after he or she retires.
- A key objective is to shift some of the income to retirement, when he or she will likely be in a lower marginal income tax bracket.
- The employer loses the current income tax deduction it would have enjoyed if the income had been paid to the executive rather than deferred.
Typical conditions include
- remaining with the employer until retirement and
- agreeing not to compete for a certain period following retirement.
Split-Dollar Plan
- either the executive or the employer may own the policy.
- the employer’s portion of the annual premium equals the cash value increase that year; the employee pays the balance.
- At the insured’s death, the proceeds are split between the employer and the employee’s beneficiary.
- An amount equal to the cash value (the amount the employer paid into the policy) is paid to the employer.
- The balance is paid to the employee’s beneficiary.
If the insured owns the life insurance policy under the split-dollar plan, the portion of the premium the employer pays may be considered taxable income to the employee.
Describe how and when lfe insurance is used for Business Continuation and Growth
Life insurance is often used for business continuation purposes. Businesses must often incur debt to expand or to invest in new products or new markets.
Life insurance is the ideal means by which funds can be made available, precisely at the time they are needed, to pay off the company’s debt and help it continue in business. When an insured business owner dies, the new owner can continue the business uninterrupted.
What is a COLI?
List 6 characteristics of a COLI.
List 3 reasons why employers use them.
Corporate-Owned Life Insurance (COLI) -
- exclusively benefits the employeer
- typically covers lower level employees who are insured for the benefit of the corporation
- Usually reserved for very large corporate employers or organizations.
- Under a COLI plan, the corporation is the owner and beneficiary of individual policies on individual employees.
- Small amounts are sometimes paid to the employee’s family.
- The policies can remain in place even after the employee quits or retires.
- funds to cover costs that would arise in replacing an employee.
- used to help cover the employee benefit liabilities
- many companies do so as a means of bringing in tax-favored revenue.
In some cases, corporations with COLI plans have taken out the insurance policies without informing their employees. A number of states have outlawed COLI plans if the employee is not notified and does not consent to the coverage.
