Situation: Using life insurance as a funding vehicle for a buy-sell arrangement gives rise to several potential tax traps, especially in out-of-the-ordinary owner/beneficiary structures. To this author it seems that more than almost any other area, buy-sell agreement funding, modification, and termination give rise to potential transfer-for-value traps. This Counselor’s Corner discusses some of the most frequent buy-sell situations that result in adverse taxation under the transfer-for-value rule.
Solution: Let’s first review how the transfer-for-value rule works and why it can be so detrimental to a buy-sell situation.
Have the limitations of qualified plan funding reduced the ability of your business clients to provide highly compensated executives with retirement benefits? Would your business clients be interested in providing a supplemental benefit to a select group of key executives as long as the arrangement binds the executive to the company? Or, do you have a business owner who wants to provide a retirement benefit for some of his key employees, but does not want to be tied into the non-discrimination rules of qualified plans? If so, a Supplemental Executive Retirement Plan (SERP) may provide a solution. Following is an example of how a SERP works.
Example of How a SERP Works
ABC, Inc. is a consulting company structured as a regular C corporation that detects and prevents fraud for the government. The company has 250 employees. Ten of the employees are critical to the success of the business. As a result, they are highly sought after by competitors. ABC, Inc. is willing to incur additional costs to keep them but prefers to use the money in a way that ties the executives to the company. The company’s objective is to provide a benefit plan that acts as “golden handcuffs” rather than paying higher salaries.
Beginning January 1, 2020 all life insurance policies must meet:
• The new 2017 CSO mortality tables, and
• Principle-Based Reserving (PBR) requirements.
Life insurance products that don’t meet both requirements must be issued and paid prior to December 31, 2019. There are no exceptions to this deadline.
What does this mean to you and your clients? More
As the end of the year approaches, life insurance carriers are in a mad dash to implement product changes mandated by the new 2017 CSO mortality tables and the Principle-Based Reserving (PBR) requirements. Most carriers have already updated their term and no-lapse guarantee universal life products to meet these new requirements, but many cash accumulation products still need to be revised.
Why did carriers wait to the end of the year to make changes to their cash accumulation products?
A couple of real-life cases will demonstrate why carriers delayed implementation of the CSO/PBR requirements for these products and the unfortunate consequence of this delay.
CASE FACTS: More
Situation: When the financial future of a business is dependent on the specialized skills, knowledge, or influence of a person or persons, the business should seriously consider acquiring insurance to help cover its potential loss at the death of such employee. Such insurance coverage is usually referred to as key person life insurance.
A key employee can be either an owner or an employee. What distinguishes someone as a key person is that his or her loss would severely impact a business until a replacement could be found and trained. Many businesses, especially those that are small or medium sized, depend on the skills and talents of one or more key individuals for their growth and continued success. In fact, some companies could not survive if a key employee suddenly died.
The hardest part in working with business owners is getting them to purchase the life insurance they need. However, once the buying decision is made, the next most difficult challenge may be getting the insurance carrier to issue the amount applied for. Packaging the case is critical, particularly when large amounts are being requested. The following are tips that can help you to best position your business insurance cases.
General Guidelines to Positioning the Case with the Insurance Carrier
We’re focusing this month on various business strategies as part of our quarterly theme Let’s Get Down to Business. A situation recently came across the desk of our advanced planning attorney that illustrates the distinct DBS advantage: we have the advanced resources that work for you and your clients!
A business owner wanted to set up a deferred compensation plan funded with life insurance for three people involved in the business but 2 of the 3 individuals were not insured. One was a 100% owner of pass – through business so it did not make sense for her because of the double taxation involved but wanted to make arrangements for the other two. The question very clearly became: How can we proceed with one uninsurable when carriers do not permit a substitution of insured?
The solution was to combine two plans with the cash value of one policy. We insured the young insurable on a split dollar basis. We then added a key person portion so if the young person died before the older uninsurable’s retirement a portion of the death benefit would go to the business to fund his retirement. The balance would go to the young person’s family under the terms of the split dollar. If the younger lived, the policy cash value was sufficient to create income under a deferred comp for the older while also sustaining the policy to either start a deferred comp for the younger or continue as split dollar. Problem solved with flexibility added.
Building a successful business is not an easy task. Often, entrepreneurs and their families place personal needs second to business demands during the start-up and growth years. As the years pass, the business begins to appreciate, with prosperity just around the corner. However, the untimely death of the entrepreneur may mean that rewards never materialize for the heirs, and years of sacrifice go for naught.
In situations where business owners have a desire to equalize the benefits between the first and last to die and they agree that a deceased owner’s heirs should share in the anticipated future appreciation, the “no-sell buy-sell” may be the answer.
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Oftentimes, the most valuable assets of any business are the key people who contribute most to its success. They generate revenue, handle major responsibilities and have a unique wealth of knowledge that seems irreplaceable.
Help your clients consider the amount of time and money it would take to replace their top talent. If their loss would create a financial burden that puts the business at risk, a key person insurance policy is a simple and efficient solution.
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