How to address key employees from a Business Strategy standpoint.
One way to address key employee strategies is for the employer to apply for and own life insurance on the key employee. The insurance premiums are paid by the Employer and all policy cash values and death benefit are property of the Employer.
Because of cash values and death benefits, these life insurance policies result in little or no cost to the Employer and, in many cases, a profit. The cash value of the policy is an asset of the Employer and may be borrowed or withdrawn for emergencies or temporary working capital.
In order for life insurance to be purchased on someone other than yourself, there must be what is considered “insurable interest”. The employer and employee relationship meets that criteria.
There are reasons for owning life insurance on a key employee and they may be the following.
Employer Indemnification: The insurance coverage is purchased to reimburse the Employer for lost services of the employee. In order to calculate the appropriate amount of insurance needed, the employer should calculate the gross revenue created by the employee and apply it to the time frame the employer could reasonably find a replacement for the loss of revenues.
Ownership Redemption: If the Executive also owns an interest in the firm and this interest will be redeemed at death, the Executive should be insured with Key Employee insurance for the amount of the expected redemption.
IRC Section 303 Stock Redemption: If the Employer is a Corporation and the Executive is a Stockholder whose stock value will exceed 35% of his/her Adjusted Gross Estate, the special benefits of a “303 stock redemption” are best funded with a Corporation-owned life insurance policy.
Death Benefit Only Salary Continuation Plans: With this plan, an Employer enters into a contractual arrangement with an Executive that promises, if the Executive dies prior to normal retirement while still employed by the company, the Employer will pay a certain amount of income to the Executive’s family for a designated term of years. The plan is funded with a Key Employee life insurance policy.
Since the Executive is relieved of purchasing expensive personal life insurance to duplicate the plan’s benefits, an Employer that utilizes this plan provides the Executive with the equivalent of a non-taxable salary increase. In addition, the plan helps create a nurturing employment environment for the Executive and, as a consequence, reduces replacement and retraining costs.
The Employer may provide this plan to only one Executive. If others are to be included, the Employer may select which ones along with the precise level of benefits for each participant. No IRS approval is needed; ERISA compliance is nominal.
Note: With a Death Benefit Only Salary Continuation Plan, the Employer’s benefit payments to the Executive’s family are tax deductible. Payments received by the family are taxable.
Important Note: This material is for educational purposes only. In all cases, the approval of a client’s legal and tax advisers must be secured regarding the implementation or modification of any planning technique as well as the applicability and consequences of new cases, rulings, or legislation upon existing or impending plans.