Life insurance products can be used to fund special retirement and other deferred compensation benefits for key employees or executives. This involves the use of permanent life insurance products and borrowing against the death benefit. The younger the executive is at the time the plan is set up and insurance purchases, the lower the cost to provide the same ultimate deferred compensation or bonus. Several factors come into plan in taking this from concept to reality.
Life insurance is paid with after tax dollars and yields a tax free payout, with a few unique exceptions which could come to play depending on how the executive compensation is set up. We will focus on the concept and its use with post tax dollars since that keeps it all much cleaner. The use of permanent policies is also key to these policies working, period end of story…no use of term will work in this market.
The life insurance can be purchased and owned by either the employee or employer depending on how the overall package is structured. Annual premiums are typically used although single premium plans are possible as well if it is a one-time deferred compensation bonus. The policy is structured to grow the value of the cash in the account along with the death benefit over time. Having a policy value grow over time helps make it a good place to borrow from so that money can be taken out as cash on a tax free basis. These are typically taken as loans against the policy that are repaid by the death benefits when the insured dies.
The policy is priced initially with plans for later loans against the policy. Of course there are specific estimates which have to be made about interest rates etc…at the time the policy is set up. Typically they estimate on the conservative side which could yield better returns in terms of case as loans are taken against the death benefit. These loans are then used as the deferred compensation for the executive.
Ownership of the policy briefly addressed above typically has restrictions when the policy is set up as part of a long term deferred compensation arrangement since giving immediate ownership of the policy to the executive allows them to change the policy at any time, including taking the cash value out immediately. Often the company will own it in the beginning and pass it over to the executive, or will have the executive own it with an iron clad contract that if the executive leaves early, etc. has to give the ownership back to the company. A lot ties directly to what period of time has to be worked before they can access that deferred compensation.
If the executive defers the compensation even longer than initially planned, the policy, specifically if it is an indexed life policy could grow far greater in value than initially planned yielding even greater deferred compensation than planned. Of course a more conservative approach is a whole life policy, where all of the policy growth values are guaranteed. Ultimately a conservative approach to pricing and better than expected performance of the policy is what works best, but that just doesn’t always happen that way.
One side effect perk with these policies is that in the event of an untimely death of the executive typically the beneficiary is the family. Of course this can be drafted where initially it is the company and later the executive’s family. Either way almost in all cases the family of the executive will receive at least some benefit if there is an untimely death, for no other reason than it works out as part of the deferred compensation arrangement.
When setting up policies of this nature is requires input from many people. The company executives or board, the executive receiving compensation, the agent, an attorney, and usually an advanced case team member form the insurance company. They will all want to work together going down check-lists to make sure all the “t”s are crossed and “I”s are dotted so the policy will work as expected. Also, planning it out correctly on the front end will help avoid unanticipated tax consequences later on. Protections for the company and the executive are necessary as well.
It may also be useful in these kinds of policies to involve the family tax planner as well to help ensure that the structure of the package will not create tax consequences. That is one item which should be discussed regardless, but may or may not require the tax planner or accountant to be present. It is however a key consideration to make in the process of setting up a plan.
Of course the underwriting of the policy will also play a part in the overall structure of the plan. Healthier younger executives cost less to get the same deferred compensation benefit than do older less healthy executives. There are also situations where significant medical issues may make it nearly impossible to place coverage. Again these are considerations when starting to evaluate and price plans of this nature.
Above is a general overview of the use of life insurance as part of executive compensation packages. Really, if you think you are a candidate, it’s important to get with an agent to evaluate the situation and properly plan for it. We are here to provide professional guidance in picking the appropriate insurance in Texas to meet these needs. Give us a call to help ensure you are adequate protection to protect your assets.
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