Chapter 8 Flashcards
Human Life Value Approach
calculates the amount of money a person is expected to earn over his lifetime to determine the face amount of life insurance needed, thereby placing a dollar value on the life of an individual.
Needs approach
Calculates the amount of money a family needs immediately upon the death of the insured to pay for the family’s obligations at death such as funeral expenses and basic necessities by considering the maintenance income, debts or mortgages, death taxes, probate, and dependent children’s education. Needs analysis is a method of life insurance planning which identifies the needs of an individual and the individual’s dependents.
The needs approach to personal life insurance planning may involve creating a lump sum to provide for such things as education, retirement, and charitable bequests.
The needs approach to personal life insurance planning also includes the creation of an emergency reserve fund. This fund is designed primarily to cover the cost of unexpected expenses.
The needs approach in life insurance is most useful in determining how much life insurance clients should apply for.
Examples of individual needs
- Final expense fund
- housing fund
- education fund
- monthly income
- emergency fund
- income needs if disabled or ill
- retirement income
- estate conservation (using life insurance to enable heirs to pay estate taxes)
Life insurance policy is a piece of property, just like a home. Therefore the value of this piece of property must be included in the owner’s estate at death, and may be estate taxable. The biggest advantage of life insurance as property is that when an insured dies, the policy creates an immediate estate.
Business continuation plans
a partnership dissolves by law when one partner dies. The surviving partners wish to keep their interest in the business and form a new partnership. They will need a buy-sell agreement funded with life insurance in order to accomplish this. when a sole proprietor dies the business also dies. Generally, this means that whoever is in charge of the business upon the proprietor’s death will be entrusted with selling the interest in the business.
Third party ownership of a life insurance is widely used in business insurance and estate-planning situations. Buy-sell agreements, aka business continuation agreements, are used to assure the ownership of the business is properly transferred upon the death or disability of an owner or partner.
Buy-sell funding for sole proprietors
there is a two step business continuation plan to keep the business running after the proprietor’s death, whereby the employee takes over management of the business:
Buy-sell plan: an attorney drafts a buy-sell plan stating the employee’s agreement to purchase the proprietor’s estate and sell the business at a price that has been agreed upon beforehand. This is sometimes referred to as a stock redemption plan.
insurance policy: the employee purchases a life insurance policy on the life of the proprietor. the employee is the policy owner, beneficiary, and pays the premiums. upon the proprietor’s death, the funds from the policy are used to buy the business.
Cross-purchase plans
a type of buy-sell agreement for partnerships.
each partner buys, pays premiums, and is the beneficiary of a life insurance policy on each of the other partners. The amount of the policy is equivalent to each partner’s share of the business. When one partner dies, each of the other partners receives the death benefit from the life insurance on the deceased partner, which is then used to buy the deceased partner’s ownership of the business.
entity plans
a type of buy-sell agreement for partnerships.
the partnership itself agrees to buy the deceased partner’s share of the business. entity plans are best for businesses with several partners. in this case the business purchases pays the premiums and is the beneficiary of the life insurance on each partner.
buy-sell funding for close corporations
unlike a partnership a close corporation (i.e. an incorporated family business) is legally separate from its owners. it exists after one or more owners dies. a close corporation may purchase either buy-sell plans (cross-purchase or entity). The difference is that an entity plan is termed a stock redemption plan for close corporations. Small corporations often purchase life insurance on the lives of major stockholders to fund a buy-sell agreement.
Business uses of policy loans
policy loans can be used for many business needs, such as to fund buy-sell agreements, deferred compensation for key people, and/or split-dollar arrangements.
Close corporation cross-purchase plan
similar to the partnership cross-purchase plans, a close corporation cross-purchase plan requires surviving stockholders to purchase the deceased stockholder’s interest in the company and the deceased stockholder’s estate to sell the interest to the surviving stockholders. The corporation is not part of the buy-sell plan. each stockholder owns, pays the premiums, and is the beneficiary of life insurance on each of the other stockholders in an amount equal to his share of the corporation’s purchase price.
Close corporation stock redemption plan
similar to the partnership entity plan, the corporation purchases, is the owner, pays the premiums, and is the beneficiary of life insurance policies on each stockholder. the amount of life insurance is equal to each stockholder’s share of the corporation’s purchase price. When a stockholder dies, the corporation purchases, or redeems, the deceased stockholder’s share.
key person insurance
the purpose of key person insurance is to prevent the financial loss that may ensue when an owner, officer, or manager dies. the company purchases, owns, pays the premiums, and is the beneficiary of the life insurance policy on the key person.
This allows the business to pay for:
- finding and training a replacement if the key person dies prematurely
- the reduction of profits resulting from the key person’s death
the loss of new business resulting from the key person’s death
- the loss of leadership resulting from the key person’s death
Corporate owned life insurance
contributions to a corporate owned annuity are taxed differently than individually owned annuities. If a corporation owns an annuity it must name a natural person as an annuitant. sometimes this natural person is referred to as a “measurable life”. if a natural person is named as annuitant, the interest credited to the annuity each year is generally not taxable (tax deferred). if a nonnatural entity is named an annuitant (i.e. the corporation), interest earned is taxable as ordinary income in the year credited.
There is one exception to the nonnatural person rule. if the annuity is held by a trust, corporation or other “nonnatural person”, as an agent for a natural person (i.e. a human being) interest earned continues to be tax deferred.
deferred compensation
an executive benefit an employer can use to pay a highly paid employee at a later date, such as upon disability, retirement, or death.
salary continuation plan
works the same as deferred compensation except that the employer funds the plan rather than the employee. the employer establishes an agreement whereby an employee will continue to receive income payments upon death disability or retirement