Business Planning Using Life Insurance Retain Recruit and
Business Planning Using Life Insurance Retain, Recruit and Reward
What is Business Insurance? • The purchase of life insurance by an employer on the life of an employee • Used to provide an additional benefit in an informally funded non-qualified deferred compensation plan or to protect the business in the event of the death of a key individual. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 2
Types of Business Life Insurance Plans • Key Person • Executive Bonus / REBAs • Deferred Compensation Plan • Salary Deferral • SERPs • Split Dollar • Buy-Sell Arrangements FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 3
Key Person Insurance
Key Person Insurance • Insurance Policy taken out on the life of a key employee to protect the business in case of sudden death. • A key employee is anyone in the business whose loss would affect profits and day-today operations. • Owner, Partner, or irreplaceable executive FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 5
Benefits of Key Person Insurance 6 • Protects the business from financial loss due to the death of key employee • Busines may borrow from the policy cash value* • Death benefit is received by the company directly free from income taxes** * Withdrawals and loans from life insurance policies, which are classified as modified endowment contracts, may be subject to tax at the time of withdrawal. A federal tax penalty may also apply if the withdrawal or loan is taken before age 59 ½. Withdrawals and loans also have the effect of reducing the Death Benefit and Cash Surrender Value. Consult your Financial Advisor for more information. ** Although Key-Man Insurance does not require IRS approval the business must ensure they are compliant with IRS Code 101(j) to avoid possible taxation of death benefit for policies placed after 2006. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
How Does Key Person Insurance Work? • Business purchases a life insurance policy on a key employee • Business is the owner and beneficiary of the policy • Business pays the entire premium. Insurance Policy Employee = Insured Business = Owner / Beneficiary Employee Business has on -file a signed 101(j) form by employee FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 7
Non-Qualified Executive Benefit Plans
Non-Qualified Deferred Compensation 9 • Arrangements between an employee and executive to provide key executives with additional retirement benefits • Selective and does not need to be offered to all employees • Used to retain, recruit and reward key employees FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Types of Non-Qualified Deferred Compensation Plans Employee Financed Employer/Employee Financed Employer Financed Group Plans FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 10
Employee Benefit Limits for 2015 Maximum 401(k) Contributions $18, 000. 00 Defined Benefit Amounts (Section 415) $210, 000. 00 Highly Compensated Employee $120, 000. 00 Defined Contribution Limits $53, 000. 00 Limits on Compensation from Qualified Plans $265, 000. 00 FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 11
Reverse Discrimination 12 Retirement Benefits as % of Final Salary 70% 60% 50% 40% 30% 20% 10% 0% 200, 000 225, 000 250, 000 300, 000 Retirement Income FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 400, 000 500, 000
The Power of Deferred Compensation 13 $30, 000. 00 $25, 000. 00 $20, 000. 00 $15, 000. 00 $10, 000. 00 $5, 000. 00 $10 K Invested @ 5% 10 yrs $6 K Invested @ 5% 15 yrs 20 yrs Assumes lump sum deferral amounts of $10, 000 growing over 20 years at 5% compared to a lump sum of $6, 000 ($1 -, 000 at 40% after-tax_ also growing at 5% for 20 years. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Salary Deferral Plans • • • Executives elect to defer part of their salary Often referred to as 401(k) mirror plans More flexible than standard Qualified Plans Do not have maximum deferral limits May exclude rank and file employees Executive financed plans FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 14
How Salary Deferral Plans Work 15 • Executive elects to defer a certain amount at the beginning of the year • The amount is credited to a “phantom” interest bearing account • Will be distributed for a certain period of time – starting at retirement FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
The Power of Salary Deferrals $180, 000. 00 16 Salary Deferral Withdrawals $160, 000. 00 $140, 000. 00 $120, 000. 00 $100, 000. 00 $80, 000. 00 $60, 000. 00 $40, 000. 00 $20, 000. 00 $0. 00 Deferred Non-Deferred This example assumes a one-year deferral of $55, 000 for 15 years into a phantom account growing at 7. 5%. The non-deferred cash assumes the same $55, 000 after-tax (40% income tax rate) at 7. 5%. Total for deferred is $162, 738. 25 and non-deferred is $97, 642. 95 FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
The Salary Deferral Plan – The Concept Agreement to defer a specified amount of income Life Insurance Company Executive Employer 17 Agreement to use deferral to purchase life insurance policy Employer purchases and owns the policy Specifics: • • • The executive agrees to defer a portion of income The employer agrees to provide a specific flow of income at a specific future time. The employer uses the deferred income to purchase a policy. Policy benefits are used to fund the agreed to retirement compensation. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
The Salary Deferral Plan – The Structure Employer Cash Value to fund deferred compensation 18 Executive Pre Retirement Compensation Post Retirement Compensation Tax Free death benefit to fund continuing compensation to heirs Beneficiaries Notes: • • Life Insurance Policy FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY • The Employer is able to provide significant pre and post retirement benefits on a deferred basis. The Employer’s cost is significantly reduced and stabilized with complete recovery possible through direct receipt of tax free death benefit proceeds. The executive enjoys substantial retirement and family security benefits.
Supplemental Executive Retirement Plan (SERP) 19 • Employer sponsored non-qualified deferred compensation plan • Provides retirement benefits to highly compensated executives • Can be used with qualified plans • Combats “reverse discrimination” FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
How Does a SERP Work? 20 • Corporation and select executives enter into an agreement that pays the executives a certain amount at retirement • Can be informally funded with life insurance • Employer is the owner and beneficiary of the policy. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Executive Bonus Plans 21 • Employer/executive financed plans • An arrangement between the executive and the corporation • The corporation pays the premium on a life insurance policy on the executive • Executive is the owner and beneficiary of the policy. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Advantages of a Bonus Plan 22 • Corporation • • • Simple to install No minimum or maximum lives Employer cost may be tax deductible • Executive • • • Death benefit protection Supplemental retirement income Can access the policy cash value at anytime *Withdrawals and loans from life insurance policies, which are classified as modified endowment contracts, may be subject to tax at the time the withdrawal or loan is made. A federal tax penalty may also apply if the withdrawal or loan is taken before age 59 1/2. Withdrawals and loans also have the effect of reducing the Death Benefit and Cash Surrender Value. Consult your Financial Advisor. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
How Does a Bonus Plan Work? Corporation Bonus Premium Amount Pays Premium In retirement, takes withdrawals Insurance Policy 23 Executive Pays tax to IRS on premium IRS *Withdrawals and loans from life insurance policies, which are classified as modified endowment contracts, may be subject to tax at the time the withdrawal or loan is made. A federal tax penalty may also apply if the withdrawal or loan is taken before age 59 1/2. Withdrawals and loans also have the effect of reducing the Death Benefit and Cash Surrender Value. Consult your Financial Advisor. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Restrictive Endorsement Bonus Arrangement (REBA) • Employer financed plans • Employer agrees to pay premium of life insurance policy to be owned by the executive • Executive files a restrictive endorsement with life insurance company FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 24
Advantages of a REBA 25 • Corporation • • • Distinguished compensation package Minimal set-up cost “Golden handcuffs” • Executive • Portable death benefit • Supplemental retirement income *Withdrawals and loans from life insurance policies, which are classified as modified endowment contracts, may be subject to tax at the time the withdrawal or loan is made. A federal tax penalty may also apply if the withdrawal or loan is taken before age 59 1/2. Withdrawals and loans also have the effect of reducing the Death Benefit and Cash Surrender Value. Consult your Financial Advisor. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
REBA Agreement 26 • Prevents the executive from • • Surrendering the cash value Taking loans and withdrawals from the policy Changing ownership Using the policy as collateral • Executive Can • Name the beneficiary *Withdrawals and loans from life insurance policies, which are classified as modified endowment contracts, may be subject to tax at the time the withdrawal or loan is made. A federal tax penalty may also apply if the withdrawal or loan is taken before age 59 1/2. Withdrawals and loans also have the effect of reducing the Death Benefit and Cash Surrender Value. Consult your Financial Advisor. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Split Dollar Arrangements
Advantages Split Dollar Plans • Corporation • • Death benefit protection Access to cash values Selective Simple to implement • Executive • Death benefit protection • Protects insurability FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 28
How Does a Split Dollar Plan Work? • Corporation and executive enter into an arrangement • The corporation will pay the bulk of the premium • The executive pays the economic benefit amount. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 29
Endorsement Method • Mandatory for plans when the business seeks to recover amount in excess of premium paid, i. e. key person indemnity or deferred compensation. • Ideal when control of the plan is to be with employer providing benefit, or a Non-Owner employee FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 30
Endorsement Method 31 Policy Premium Split Relative Premiums Executive [CATEGORY NAME] FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Endorsement Method 32 Policy Proceeds Split $2, 000 $1, 800, 000 $1, 600, 000 $1, 400, 000 $1, 200, 000 $1, 000 $800, 000 $600, 000 $400, 000 $200, 000 $0 1 2 3 4 5 Executive Death Benefit 6 7 8 9 10 11 12 Excess Corportate Cash Value FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 13 14 15 16 17 18 Corporate Return of Premium 19 20
Collateral Assignment Method • In most cases it’s the customary method used to remove proceeds from majority shareholder’s estate • Debtor-creditor relationship is created • Places effective control in hands of insured/executive • Ideal when ultimate objective is to provide continuing post-retirement coverage FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 33
Collateral Assignment Method 34 Policy Cash Value Split $900, 000 $800, 000 $700, 000 $600, 000 $500, 000 $400, 000 $300, 000 $200, 000 $100, 000 $0 1 2 3 4 5 6 7 8 Balance To Executive FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 9 10 11 12 13 14 15 Employer Return of Premium 16 17 18 19 20
Collateral Assignment Method 35 Policy Proceeds Split $2, 000 $1, 800, 000 $1, 600, 000 $1, 400, 000 $1, 200, 000 $1, 000 $800, 000 $600, 000 $400, 000 $200, 000 $0 1 2 3 4 5 6 7 8 9 10 Balance To Executive's Beneficiary FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 11 12 13 14 15 16 Employer Return of Premium 17 18 19 20
Split Dollar Summary
Buy-Sell Arrangements
Buy-Sell Arrangements • A buy-sell arrangement is a binding agreement in which one party agrees to sell the interest and the other party will buy the interest. • Transactions occur • At death • At retirement • At disability FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 38
Types of Buy-Sell Arrangements • Stock Redemption or Entity Purchase • Cross Purchase • Wait and See FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY 39
Stock Redemption or Entity Plan 40 • The business agrees to buy life insurance on the lives of the owners • Agreement states that the owners or their estates agree to sell interest in the business and the business agrees to buy it. • Business is the owner and beneficiary of the life insurance policy. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Stock Redemption or Entity Plan During Lifetime 41 Insurance Co. Pays Premiums Business Agreement Owner A Agreement Owner B The Business owns insurance policies on each owner FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Stock Redemption or Entity Plan Upon A’s Death 42 Insurance Co. Pays Death Benefit Stock Passes Business Interest Cash Owner B A’s Family or Estate FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Cross-Purchase Plan 43 • Owners take life insurance policies out on each other • Survivor purchases deceased owner’s shares in company • Life insurance proceeds help to provide the funds FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Cross Purchase Plan 44 During Lifetime Insurance Co. Business Pays Premiums Owner A Owner B Each Owner Obtains Insurance On the Other FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Advantages of Cross Purchase 45 • Purchasing shareholder will get step-up in cost basis • Life insurance proceeds are income tax free • Avoids possible treatment of redemption as a dividend. • No AMT or accumulated earnings tax problems • Can reallocate ownership of the surviving owners by purchasing varying amounts of the deceased owner’s shares. FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
Cross Purchase Plan 46 Upon A’s Death Insurance Co. Stock Passes Pays Death Benefit Business Interest Cash A’s Family or Estate FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY Owner B
Wait and See Agreement 47 • Owners agree to buy and sell their shares but the price is not determined until death, retirement or disability • Owners purchase life insurance on each other • Business has right of first refusal, owner second right, and the business must purchase remaining shares FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
“Wait and See” funded by owners During Lifetime 48 Pays Premiums Insurance Co. Pays Premiums Business Pays Premiums Agreement Owner A Owner B Each Owner Obtains Insurance On the Other FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY
“Wait and See” funded by owners Business Upon A’s Death Insurance Co. Option to Purchase Stock Passes 49 1 st Must Purchase $ Death Benefit $ 3 rd 2 nd $ A’s Family or Estate FOR BROKER / DEALER AND FINANCIAL ADVISOR USE ONLY Owner B Option to Purchase
Business Planning Using Life Insurance For More Information Georgetownn Financial Group, Inc. Phone (203) 544 -9300 Fax (203) 544 -9967 info@gfginc. com
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