Presentation on theme: "Business Planning Using Life Insurance"— Presentation transcript:
1 Business Planning Using Life Insurance Retain, Recruit, and RewardPurpose and Scope of this Presentation. This presentation is intended to be used by Sales Offices to give producers a broad overview of business life insurance plans. It is intended to educate producers on the opportunities, benefits and applicability of the business uses of life insurance.Manulife Financial offers this presentation to qualified users to assist them in adding value to their customer relationships. This presentation should not be construed as a specific “plan” or specific legal, tax or accounting advice. Whether any of the presentation topics are applicable to specific individuals can only be determined by the individual and his or her professional advisors.This material is for informational purposes only. Although many of the topics presented may also involve tax, legal, accounting, or other issues, neither The Manufacturers Life Insurance Company (U.S.A.), Manulife Financial Securities LLC nor any of its agents, employees, or registered representatives, are in the business of offering such advice. Individuals interested in these topics should consult with their own professional advisors to examine tax, legal, accounting, or financial planning aspects of these topics.Manulife Financial and the block design are registered service marks and trademarks of The Manufacturers Life Insurance Companyand are used by it and its affiliates including Manulife Financial Corporation. Copyright The Manufacturers Life InsuranceCompany (U.S.A.) All rights reserved. MLI Expires 12/31/2002.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.THIS MATERIAL MAY NOT BE COPIED OR USED WITH THE PUBLIC.
2 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. An IntroductionBusiness Insurance is:The purchase of life insurance by an employer on the life of an employeeUsed 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.People commonly think of life insurance as a personal resource used to protect their families from the financial impact of the loss of a loved one. However, there are many ways that life insurance can benefit business owners and their employees. Businesses may use life insurance to provide benefits to their employees, to protect themselves from the loss of a key person, or to plan for the continuation of the business should one of its owners pass away. This presentation will review the benefits and types of arrangements that are commonly used in the business world.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
3 Business Life Insurance Plans Key PersonExecutive Bonus/REBAsDeferred Compensation PlanSalary DeferralSERPsSplit DollarBuy-Sell ArrangementsHere is a list of the major uses of life insurance in the business market. On the following slides is an overview of each application.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
4 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Key Person InsuranceInsurance 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-to-day operationsOwner, Partner, or irreplaceable executive.What is Key Person Insurance?Key person insurance is an insurance policy taken out by a business on the life of a key employee to protect the business in case of his or her death.The key employee can be anyone in the business whose loss would be significant or could result in a loss of business. This could be the owner, a partner, or an employee whose knowledge and contribution to the business is critical to the success of the business.Who is a Key Person? Someone who has…CreativityExpertise of foresight, subjects or peopleFavorable rapport with creditorsFinancial acumenImportant contactsProduction controlReputationSales abilityFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
5 Benefits of Key Person Insurance Protects the business from financial loss due to the death of key employeeBusiness may borrow from the policy cash value*Death benefit is received by the company directly free from income taxes.Key person life insurance is simple to implement. It does not need IRS approval.With key person life insurance, the business has death benefit protection in case of death, and is able to access the potential cash values of the life insurance policies for cash flow in case there is a disruption to business operations or sales. The proceeds can stabilize the company financially so that creditors are not worried about the business as a going concern. The proceeds can be used to offset the cost of finding and training a replacement for the key person.From an underwriting perspective, generally 10 times income is the limit for the face amount on key person insurance.*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 Manulife Financial Representative.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
6 How Does Key Person Insurance Work? Business buys a life insurance policy on a key employeeBusiness is the owner and beneficiary of the policyBusiness pays the entire premiumBusinessManulife FinancialInsurance PolicyPlan: Key Person Life InsuranceObjective: Provide protection to offset financial losses to a business due to the death of a valuable employee.Premium Payor: BusinessOwner: BusinessBeneficiary: Business. The proceeds offset reduced profits and help pay for replacement of the deceased employee.Income Tax Issues:Business: Premiums not deductibleEmployee: No impactDeceased’s Family: No direct benefits from Key Person insuranceEstate Impact: Proceeds not income taxable. But value of business is increased by the proceeds. Therefore, if the owner is also the insured the value of insured/owner’s estate is increased by the death benefit.EmployeeFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
7 Non-Qualified Executive Benefit Plans There are many forms of Non-Qualified Executive Benefit plans (NQEB). The next slide contains an overview of the various forms of NQEB.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
8 Non-Qualified Deferred Compensation Arrangements between an employer and executive to provide key executives with additional retirement benefitsSelective and does not need to be offered to all employeesUsed to retain, recruit, and reward key employeesExecutive benefit plans are arrangements between an employee and an employer which provide the key employee with a form of supplemental retirement income or other benefits in addition to standard qualified plans, such as 401(k) plans.These plans may not be subject to the same tax and labor law (ERISA) requirements as qualified plans. These non-qualified plans are selective and do not have to be offered to all employees.Ordinarily, these plans are used as an incentive to retain, reward, and recruit key and highly compensated employees. These employees often encounter employee benefit limitations and restrictions.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
9 Types of Non-Qualified Deferred Compensation Plans Employee FinancedEmployer/Employee FinancedEmployer FinancedGroup PlansThere are four main types of Non-Qualified Deferred Compensation Plans1. Employee Financed - these include Pure Deferred Compensation Plans and Salary Deferral Plans. These type of plans are financed with employee money.2. Employer/Employee Financed - these include Section 162 Executive Bonus Plans, REBAs, Split Dollar Arrangements. These are financed with contributions from both the employer and the employee.3. Employer Financed - These include SERPS, and Excess Benefit Plans. These plans are financed with employer money only.4. Group Plans - These include Group Universal Life and Group Term Carve Out. Sponsored plans that may be offered to a particular group of employees.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
10 Employee Benefit Limits for 2002 Each year the government publishes new tables that are adjusted for inflation, such as limits on plan contributions. In 2002, the annual contribution limit for 401(k) plans is $11,000. The maximum benefit amount from a defined benefit plan is $160,000, and the definition of a highly compensated employee is someone who earns $90,000 or more. The annual contribution limit for defined contribution plans is $40,000, and for calculating contributions to qualified plans the compensation limit is $200,000.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
11 Reverse Discrimination As a general rule most companies strive to pay employees at least 60% of the final 3-year total of salary and incentive compensation in retirement benefits.Because of the qualified plan limitations, highly compensated individuals who are making over $200,000 will not receive the entire 60%.For example an executive who makes $300,000 will only receive $120,000 a year in retirement benefits.That is only 40% of his final salary.Thus the executive is faced with “reverse discrimination” because they make too much money and are not eligible to receive the same amount in qualified plan benefits as people who make less than $200,000 a year.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
12 The Power of Deferred Compensation This slide compares the power of deferring compensation vs. taking the money and investing in an account.We are assuming a lump sum deferral of $10,000 growing over 20 years at 8%.We are comparing this to taking the $10,000 and paying taxes on it (40% tax bracket) and investing the balance ($6,000) at 8% over 20 years.The breakdown$10, Yr 10 -$ 21, 589, Yr 15 - $31,722, Yr 20 -$46,610$6,000 - Yr 10 -$12, 954, Yr 15 - $19,033, Yr 20 -$27,966Assumes lump sum deferral amount of $10,000 growing over 20 years at 8% compared to a lump sum of $6,000 ($10,000 at 40% after-tax) also growing at 8% for 20 years.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
13 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Salary Deferral PlansExecutives elect to defer part of their salaryOften referred to as 401(K) mirror plansMore flexible than standard QplansDo not have maximum deferral limitsMay exclude rank and file employeesExecutive financed plansA Salary Deferral Plan is a plan in which an executive can elect to defer part of his or her salary, bonus, and commission.Some Salary Deferral Plans are structured to supplement or “mirror” a 401(k) plan. These deferral plans may be referred to as 401(k) Mirror Plans.Salary Deferral Plans are more flexible than the standard 401(k) plan because they do not have a maximum deferral limit and may discriminate against rank and file employees.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
14 How Salary Deferral Plans Work Executive elects to defer a certain amount at the beginning of the yearThe amount is credited to a “phantom” interest bearing account.Will be distributed for a certain period of time - starting at retirementDistributions from salary deferral plans usually last for 15 years starting at retirement or termination of employment.At the death of the participant the account balance will also be distributed to the spouse.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
15 Power of Salary Deferrals In the deferred compensation account the executive will be able to take out $30,206 a year in retirement compared to the non-deferred account in which he/she will only be able to receive $18,123 a year.A difference of $12,083 per year.This example assumes a one-year deferral of $55,000 for 15 years into a phantom account growing at 10%. The non-deferred cash assumes the same $55,000 after-tax (40% income tax rate) at 10%. Total for deferred is $ and non-deferred is $137,849.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
16 The Salary Deferral Plan The ConceptExecutiveAgreement todefer a specifiedamount of incomeAgreement touse deferral topurchase lifeinsurance policyEmployerEmployer purchases and owns the policySpecifics:The executive agrees to defer a portion of incomeThe 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.Plan: Salary DeferralObjective: Retention of key executive by deferring taxable income and providing salary continuation into retirement.Premium Payor: BusinessOwner: BusinessBeneficiary: Business (policy proceeds are used to recover the business’ cost of the plan).Income Tax Issues:Business: Premiums not deductible. Proceeds not taxable (except gain under living proceeds.) Benefit payments deductible as long as they qualify as reasonable compensation.Employee: Employer-paid premiums not treated as taxable income Income taxes deferred until executive receives benefits, which are considered ordinary income.Deceased Family: Benefit payments are income taxable as ordinary income when received. The first $5,000 may be received income tax-free by the surviving spouse, if the rights are forfeitable prior to death.Estate Impact: The present value of the benefits is included in the executive’s gross estate.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
17 The Salary Deferral Plan The StructureEmployerExecutivePre Retirement CompensationCash Valueto funddeferredcompensationPost RetirementCompensationBeneficiariesTax Freedeath benefitto fund continuingcompensation to heirsNotes: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 proceeds.The Executive enjoys substantial retirement and family security benefits.The employer will pay a pre-retirement benefit to the deceased executive’s beneficiary if death occurs prior to retirement.At retirement the employer can take withdrawals and loans* from the policy to fund the benefits that are payable to the executive.At the death of the executive the employer will recover the cost of the policy and the benefits paid to the executive and/or the beneficiary.*Withdrawals and loans from life insurance policies, which are classified as modified endowment contracts, may be subject to income 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.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.17FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
18 Supplemental Executive Retirement Plan (SERP) Employer sponsored non-qualified deferred compensation planProvides retirement benefits to highly compensated executivesCan be used with qualified plansCombats “reverse discrimination”A SERP is a non-qualified deferred compensation plan that allows employers to provide retirement benefits to key employees beyond those provided by the qualified plan. The plan is funded by the employerIt is an effective way for an employer to supplement an executive’s retirement compensation.An excellent way to provide highly compensated executives with supplementalretirement income• No cost to the executive• A great way to provide retirement benefits beyond those provided by qualified plans• An attractive way to reward select key employees with tax-deferred retirement benefitsFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
19 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. How Does a SERP Work?Corporation and select executives enter into an agreement that pays the executives a certain amount at retirementCan be informally funded with life insuranceEmployer is the owner and beneficiary of the policyThe employer and the executive enter into an agreement. This agreement states that the employer will pay the executive a certain amount of money, either over a period of time or in a lump sum, upon death, retirement or termination of the plan.The executive does not make contributions to the plan. The graphics on the previous salary deferral slides would be identical for a SERP, except for the fact that employer dollars are used to fund the program rather than employee dollars.The income received by the executive is taxable as ordinary income and the employer will receive a tax deduction assuming such income is reasonable compensation under the federal tax code.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
20 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Executive Bonus PlansEmployer/executive financed plansAn arrangement between the executive and the corporationThe corporation pays the premium on a life insurance policy on the executiveExecutive is the owner and beneficiary of the policyAn Executive Bonus Plan is also referred to as a 162 Bonus Plan.Typically, this arrangement occurs between an employer and an executive. The employer provides a bonus to the executive by paying the premium on a life insurance policy.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
21 Advantages of a Bonus Plan CorporationSimple to installNo minimum or maximum livesEmployer cost may be tax deductibleExecutiveDeath benefit protectionSupplemental retirement incomeCan access the policy cash value at anytimeThe employer determines which executives to include in the bonus plan.The executives then apply for life insurance. The employer provides a bonus to each executive by paying the premium on a life insurance policy.The executive is responsible for paying the income tax due on the bonus. However, the employer may elect to bonus the executive this amount (the income tax due).This is called a double bonus arrangement. With a double bonus arrangement, the executive does not incur any out-of-pocket cost.At retirement, the executive will be able to use the policy’s potential cash value to supplement his or her retirement income.Moreover, the executive has been provided with permanent life insurance for the benefit of his or her family.*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 Manulife Financial Representative.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
22 How Does a Bonus Plan Work? Bonus premium amountCorporationExecutivePays tax to IRS on premiumPays premiumManulifeFinancialInsurancePolicyIn retirement, takes withdrawalsIRSPlan: Executive Bonus (Section 162)Objective: Retention of key employees by providing life insurance and retirement benefits.Premium Payor: BusinessOwner: Insured ExecutiveBeneficiary: Designated by covered employeeIncome Tax Issues:Business: Premiums income tax deductible as long as they qualify as reasonable compensation.Employee: Employer-paid premiums treated as taxable income. Benefits are not taxable (except gain under living benefits).Deceased’s Family: Proceeds not taxable.Estate Impact: The proceeds are included in the insured-executive’s gross estate due to policy ownership. If the policy is owned by an ILIT, it can avoid estate taxes.*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 Manulife Financial Representative.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
23 Restrictive Endorsement Bonus Arrangement (REBA) Employer financed plansEmployer agrees to pay premium of life insurance policy to be owned by the executiveExecutive files a restrictive endorsement with life insurance companyA REBA is an Executive Bonus Plan with a restriction on the executive’s ability to access policy values for a stated period of time. The REBA agreement typically states that as long as the executive works for the employer, the employer will continue to pay the bonus. Even though the executive is the owner of the life insurance policy, he or she must file a restrictive endorsement with the life insurance carrier at the time the policy is purchased.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
24 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Advantages of a REBACorporationDistinguished compensation packageMinimal set-up cost“Golden handcuffs”ExecutivePortable death benefitSupplemental retirement incomeEmployer• Minimal set-up cost• Selective participation allowed• Encourages employee loyaltyExecutive• Portable death benefit• Source of supplemental retirement income• Not subject to qualified plan limits and penalty provisions*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 Manulife Financial Representative.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
25 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. REBA AgreementPrevents the executive fromSurrendering the cash valueTaking loans and withdrawals from the policyChanging ownershipUsing the policy as collateralExecutive canName the beneficiaryThis arrangement restricts the executive from:Surrendering the cash valueTaking loans and withdrawals from the policyChanging ownership, andUsing the policy as collateral.The executive does retain the right to name the beneficiary. The agreement may also contain a vesting schedule. Some of the most popular vesting periods are: one-year rolling, five-year rolling, and vesting at retirement.*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 Manulife Financial Representative.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
26 Split Dollar Arrangements A split dollar arrangement involves two or more parties who agree to share or “split” the insurance death benefits, premiums, and cash value.The life insurance provider is not part of this arrangement. Split dollar arrangements have been used for over 40 years as a form of executive compensation.The Internal Revenue Service issued Notice in January 2002 to clarify prior rulings regarding the taxation of split-dollar arrangements for the purchase of life insurance. The notice provides interim guidance for the taxation of split-dollar pending publication of further guidance by the IRS.For the most part, split dollar is alive and well. However, there are a few adjustments that split dollar advisors will have to make. It is out of the scope of this presentation to go into the details.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
27 Advantages of Split Dollar Plans CorporationDeath benefit protectionAccess to cash valuesSelectiveSimple to implementExecutiveProtects insurabilityThere are basically two types of Split Dollar: Endorsement and Collateral Assignment.Split dollar arrangements can be simple to implement and beneficial to both the employer and the executive.It can be a low-cost plan to set up since the employer retains an interest in the death benefit at least equal to the amount of premiums paid by the employer.Another advantage is that the employer can select the executives that are covered.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
28 How Does a Split Dollar Plan Work? Corporation and executive enter into an arrangementThe corporation will pay the bulk of the premiumThe executive pays the economic benefit amountTypically, the employer and the executive enter into an arrangement in which the executive agrees to pay the economic benefit cost on that portion of the policy death benefit payable to the beneficiary selected by the executive.The economic benefit cost is measured by the value of the term insurance pro-vided to the executive (Table 2001 rates or the insurer’s alternative term rates). The employer agrees to pay the balance of the premium.Depending on the type of Split Dollar Plan, at termination of the agreement, the employer will own the policy, or in the case of a Collateral Assignment, the policy will be rolled out to the executive.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
29 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Endorsement MethodMandatory 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 the employer providing benefit, or a Non-Owner Employee.The employer owns the policy and thereby maintains full control of the contract. This method also makes it easier to combine the life insurance benefit with other non-qualified plans such as key person, or deferred compensation plans.Corporate Employer Costs - The corporation gets back every dollar it puts in, either through the cash value or the death benefit. Its effective cost is a loss of the after-tax corporate earnings it would have earned if the executive split- dollar plan did not exist.Insured Executive Costs - The after-tax cost of the executive’s benefit is less than annual renewable term, level term plans, or group term insurance.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
30 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Endorsement MethodPolicy Premium SplitExecutiveTypically, under the Endorsement Method the employee’s cost is equal to the cost of term insurance (Table 2001).Economic Benefit (Table 2001) conceptThe executive in effect is receiving an "economic benefit." For example, if your employer gave you the use of a car for personal use, you would have to include the value of this benefit in your income. The benefit, in this case, is the enjoyment of the life insurance protection.The IRS requires the employer to include in the executive’s income each year the cost of the executive 's portion of the death benefit (i.e., the "amount at risk"), minus what the executive contributes to that cost. The value of the term insurance coverage is measured by the lower of the Table 2001 rates or the insurance company's currently available annually renewable one‑year term rates.If the cost of term insurance is taxable as compensation to the executive, the employer should be able to deduct the amount that the executive has to report as income.It is generally believed that collateral assignment and endorsement split dollar are subject to the same income and gift tax treatment. We will discuss this more later but, keep in mind that the Table 2001 charge applies to both Split Dollar methods.CorporateFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
31 Endorsement Method Policy Proceeds Split Executive Death Benefit Excess Corporate Cash ValuePlan: Split Dollar - Endorsement MethodIn this graph you can see that the employer receives an amount equal to the cash value (the blue & green portions) and the balance of the death benefit (pink) is payable to the executive’s beneficiary.Summary:Objective: Retention of key selected executive by helping him/her purchase life insurance at a relatively low cost.Premium Payor: Business pays majority of the premium; key executive pays cost of the economic benefitOwner: BusinessBeneficiary: Designated amount paid to insured executive’s beneficiaryIncome Tax Issues:Business: Premiums not income tax deductible.Employee: Employer-paid premiums not treated as taxable income (other than economic benefit amount). Death Benefits are not income taxable.Deceased’s Family: Proceeds are not income taxable.Estate Impact: The proceeds may be included in the insured-executive’s gross estate if the endorsement is owned by the executive and not by his or her ILIT.Corporate Return of PremiumFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
32 Collateral Assignment Method In most cases it’s the customary method used to remove proceeds from majority shareholder’s estateDebtor-creditor relationship is createdPlaces effective control in hands of insured/executiveIdeal when ultimate objective is to provide continuing post- retirement coverageIn estate planning cases this is the preferred method in order to remove or exclude the proceeds from the employee’s estate. This method is also used with Private Split Dollar.With the Collateral Assignment Method the premium payer (usually the employer) cannot recover more than premium advanced without incurring an Income Tax Liability. Any excess over premium paid recovered during the life of the insured would be taxable as income to the employer. However, any excess over premium paid recovered as a DEATH BENEFIT by the employer would not be income taxable* to the employer or the employee’s beneficiary.The effective control of the policy is placed in the hands of the employee because the employee or the employee’s trust owns the life insurance policy.The Collateral Assignment Method is ideal when the ultimate objective is to provide continuing post retirement coverage and to put control of the policy in the hands of the executive/third party. In addition to estate liquidity, if the executive’s objective is to provide retirement benefits, the cash values can be used for this purpose.*Assuming no transfer for value problem and no alternative minimum tax (AMT) issues.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
33 Collateral Assignment Method Policy Cash Value SplitBalance to ExecutiveEmployer Return of PremiumThis graphic shows the split of the cash value between the employer and the executive.The employer receives an amount equal to the premiums paid by the employer and the balance is paid the the executive’s beneficiary. This is also known as Equity Split DollarIn the early years the employer receives the entire cash value because it is less than the total premiums paid.As the cash value increases and rises above the amount that is payable to the employer, the balance belongs to the executive. Is this a good deal for the executive? Let’s return to our example of $1,000,000 of Manulife UL Age 45 Non-Smoker Preferred and look at the value. In this case the employer is going to give the executive a bonus to help him pay for the term cost of the split dollar insurance. By doing it this way, the employer gets to deduct the bonus as compensation and the executive will have to include the bonus in his income. If the executive is in the 40% income tax bracket, the cost picture looks like this:The data shown is taken from an illustration and is not intended to project actual performance. Current interest rates and/or dividend rates and values (unless indicated otherwise) are not guaranteed.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.YearExecutiveExecutiveNet DeathBonusAfter-TaxBenefit$262 for almost a $1,000,000 of insurance is a good deal. Manulife 10 would cost $1,260 for the first ten years.Cost1$655$262$993,0462700280986,1363734294979,2614788315972,4395$830$332$965,659
34 Collateral Assignment Method Policy Proceeds SplitBalance to Executive’s BeneficiaryPlan: Split Dollar – Collateral Assignment MethodIn this graph you can see that the employer receives an amount equal to the premiums paid (green portion) and the balance of the death benefit (blue) is payable to the executive’s beneficiary.Objective: Retention of key selected executive by helping him/her purchase life insurance at a relatively low cost.Premium Payor: Business pays majority of the premium; key executive pays cost of the economic benefitOwner: Executive or third partyBeneficiary: Cost recovery to business, balance paid to insured employee’s beneficiaryIncome Tax Issues:Business: Premiums not income tax deductible.Executive: Employer-paid premiums not treated as taxable income (other than economic benefit amount). Death Benefits are not income taxable.Deceased’s Family: Proceeds are not income taxable.Estate Impact: The proceeds are included in the insured-executive’s gross estate if policy is owned by the insured executive.Corporate Return of PremiumFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
35 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Split Dollar SummaryUnder the Collateral Assignment Method, the employer only advances premiums to the executive and does not own the contract. With the Endorsement Method the employer has full ownership of the contract and can divided up the benefits in any way it so desires.To help you differentiate between the two methods, think of it this way: the Collateral Assignment Method is used most in estate tax planning situations and the Endorsement Method is most often used in business and fringe benefit planning situations.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
36 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 occurAt deathAt retirementAt disabilityA buy-sell arrangement is a way to plan for the sale of a business interest upon a triggering event such as an owner’s death, disability, or retirement. A well-drafted and properly funded arrangement can protect the interests of the business owners and help facilitate the continuation of the business when they are needed most – at the death of an owner.Create Liquidity. Upon a business owner’s death, retirement, or disability, his or her family continues to need cash to pay ordinary living expenses as well as any potential estate tax liability. Estate taxes are usually due nine months after date of death. Selling a business under these circumstances can result in the family receiving less than fair market value.Set a Fair Selling Price. A business valuation strategy that is determined while all owners are active can be negotiated at arm’s length. Once a business owner leaves the business, negotiating a fair sales price becomes more difficult for the owner (or the owner’s estate) because the remaining owners hold most of the cards.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
37 Types of Buy-Sell Arrangements Stock Redemption or Entity PurchaseCross PurchaseWait and SeeBuy-sell arrangements can take different forms, including: (1) stock redemption or entity purchase, (2) cross-purchase, and (3) wait and see.The best type of arrangement depends upon several factors, including the type of business structure and the number of owners.An entity purchase arrangement allows a business to buy out its deceased owners, while a cross-purchase arrangement allows business owners to buy each other out.A wait and see arrangement is a combination of the first two types.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
38 Stock Redemption or Entity Plan 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.In this case the business will purchase the ownership/shares from the owners. It usually is a straight forward method.If life insurance is used to fund the plan, the business is the owner and beneficiary of the policies.A Stock Redemption or Entity Plan is the most efficient when:The plan requires several policies because of the number of owners, typically, more than three to five owners.If the corporation is in a lower income tax bracket than its individual owners or if there is a concern that an individual shareholder (s) will have trouble paying the premiums or concern about the policies lapsing.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
39 Stock Redemption or Entity Plan During LifetimeBusinessPays PremiumsPlan: Buy-Sell Arrangement –Stock Redemption or Entity PurchaseDuring the lifetime of the owners the business pays for life insurance on the lives of each owner. Only one policy is necessary per owner.Objective: Disposal of the business interest upon the death of an owner, by having the business purchase deceased’s interest.Premium Payor: Business.Owner: Business.Beneficiary: Business – proceeds are used by the business to buy the interest from the deceased’s owners estate.Income Tax Issues:Business: Premiums are not income tax deductible. Proceeds are not income taxable. “S” corporations will generally get a step up in basis on the entity redemption, but a “C” corporation will not.Employee: NoneDeceased’s Family: Step-up in basis usually applies. If the payments do not exceed stepped-up basis, there are no income tax consequences.Estate Impact: Purchase price paid for the deceased’s business interest is included in the gross estate. This usually equals the amount of the policy proceeds.AgreementAgreementOwner AOwner BThe Business owns insurance policies on each ownerFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
40 Stock Redemption or Entity Plan Upon A’s DeathPays Death BenefitStock PassesBusinessBusinessInterestCashAt the death of an owner, in this case A, the life insurance proceeds are received by the business. The business then purchases the stock or ownership in the business from A’s estate. In this example, B will be the 100% owner of the business and A’s family now has cash and is completely out of the business.Owner BA’s Family or EstateFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
41 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Cross-Purchase PlanOwners take life insurance policies out on each otherSurvivor purchases deceased owner’s shares in companyLife insurance proceeds help to provide the fundsA cross-purchase buy-sell agreement is an arrangement in which each owner agrees to buy the business interest of another owner. A triggering event such as the death, disability, retirement, or other termination event of an owner may lead to an ownership transition. Thus, a cross-purchase plan reflects a business continuation agreement among the owners themselves. A cross-purchase plan usually works well with five or fewer owners.Funding a cross-purchase plan typically requires multiple life insurance policies. The number of policies may be expressed as a formula with the number of shareholders (n) times the number of shareholders minus one (n-1). For example, if there are three owners, the implementation of a cross-purchase plan requires the use of six (3 times 2) policies. If there are five owners, the implementation of a cross-purchase plan requires the use of 20 (5 times 4) policies.Individual owners may pay the premiums out of their personal funds or the corporation may decide to directly pay the premiums using either a “double” bonus or split dollar arrangement.Individual owners receive death proceeds income tax free.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
42 Each Owner Obtains Insurance On the Other Cross Purchase PlanDuring LifetimeBusinessPays PremiumsPays PremiumsThis flowchart shows a simple cross purchase plan between two owners, A and B.Owner AOwner BEach Owner Obtains Insurance On the OtherFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
43 Advantages of Cross Purchase Purchasing shareholder will get step-up in cost basisLife insurance proceeds are income tax freeAvoids 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.The purchasing owners receive a step-up in basis in the acquired stock. A step-up in basis reduces the taxable gain (or increases the loss) on a subsequent disposition of the stockThe receipt of life insurance proceeds will not be subject to income tax.Life insurance used to fund the cross-purchase agreement does not increase the value of the corporation. The corporation does not reflect the value of the life insurance policies on its balance sheet.A cross-purchase plan does not encounter the possibility that redemption proceeds will receive treatment as a dividend distribution. Furthermore, the family attribution rules do not apply to cross-purchase plans.Since the corporation is not a party to a cross-purchase plan, no potential corporate AMT or accumulated earnings tax consequences exist for the policy proceeds.With a lifetime sale, the selling owner recognizes capital gains to the extent that the purchase price exceeds his or her basis.The death proceeds of life insurance owned by Owner A on Owner B’s life would not be part of Owner A’s estate for federal estate tax purposes.If there are more than two surviving owners, they could purchase different percentages of the deceased owner’s interest to restructure the ownership percentages of the surviving owners.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
44 FOR BROKER/DEALER AND GENERAL AGENT USE ONLY. Cross Purchase PlanUpon A’s DeathBusinessStock PassesPays Death BenefitBusiness InterestPlan: Buy-Sell Arrangement - Cross PurchaseObjective: Disposal of the business interest upon the death of an owner, by transferring ownership to the surviving co-owners.Premium Payor: Each partner or stockholder pays premiums for policy on the life of other partner (s) or co-stockholder (s).Owner: Each partner or stockholder owns a policy of the life of partner (s) or co-stockholder (s).Beneficiary: Each partner or stockholder is the beneficiary of the policy he/she owns on the life of the partner (s) or co-stockholder (s). Proceeds are used to buy the interest from the deceased’s owners estate.Income Tax Issues:Business: No issues, not a party to the plan.Employee: Premiums not income tax deductible and the proceeds are not income taxable.Deceased’s Family: Step-up in basis usually applies. If the payments do not exceed stepped-up basis, there is no income tax consequences.Estate Impact: Purchase price paid for the deceased’s business interest is included in the gross estate. This usually equals the amount of the policy proceeds.Owner BCashA’s Family or EstateFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
45 Wait and See Arrangement Owners agree to buy and sell their shares but the price is not determined until death, retirement, or disabilityOwners purchase life insurance on each otherBusiness has right of first refusal, owner second right, and the business must purchase remaining sharesThis type of arrangement offers flexibility because the ultimate decision about who is going to buy what is not determined until the event occurs.Normally, the business has the right of first refusal. In other words based on circumstances the business entity can purchase as much or as little of the business as it sees fit. Secondly the surviving business owners have an opportunity to purchase any remaining shares of the business. To the extent that there is any ownership shares remaining, the business entity is obligated to purchase the remainder.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
46 “Wait and See” funded by owners During LifetimePays PremiumsBusinessPays PremiumsAssume we have a corporation which is owned equally by A and B. As with both the cross purchase and stock redemption plans, the “wait and see” agreement provides for valuation of their interests; sale upon death, disability or retirement; and the specific terms of payment.However, unlike the other plans, the “wait and see” buy/sell agreement does not specifically identify the purchaser. The purchaser and amounts of purchase are not determined until AFTER the death of one of the owners.Let’s look at an example;In our example we’re going to assume that A and B purchase life insurance contracts on each other. They will own the policies, pay the premiums and be the beneficiaries.Notice that the structure in this case looks a lot like a cross purchase...the difference here is that the business entity is part of the agreement, whereas in the cross purchase plan the business entity is specifically excluded.Pays PremiumsOwner AOwner BAgreementFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.Each Owner Obtains Insurance On the Other
47 “Wait and See” funded by owners Upon A’s DeathOption to PurchaseMust PurchaseDeath Benefit$Stock Passes$1st3rdOwner BAt A’s death, his stock passes to his family or estate. At the same time, the insurance company pays an income tax free death benefit to B, as beneficiary of the contract he owns on A’s life. Exercising the agreement the following steps are implemented:1st - The business has the first option to purchase A’s stock: typically the business has days to exercise its option.2nd - If the business does not exercise its option, or purchases less than all of A’s stock, B has a second option to purchase A’s stock: typically B has days to exercise his option.3rd - The business is required to purchase any of A’s stock not previously purchased by either the business or B.Under the 1st and 3rd steps the business could obtain funds for purchasing A’s stock by borrowing the death proceeds received by B. As with the cross purchase and redemption agreements, the “wait and see” buy/sell agreement can also serve to help “peg” the value of the stock for estate tax purposes.Source: 1994 Field Guide, National Underwriter2nd$Option to PurchaseFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
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51 The Business Planning Series REBAExecutive Bonus PlansSERP SwapsSERPs/Deferred Income PlansBuy-Sell AgreementsFOR BROKER/DEALER AND GENERAL AGENT USE ONLY.
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53 Business Planning Using Life Insurance The EndManulife Financial and the block design are registered service marks and trademarks of The Manufacturers Life Insurance Company and are used by it and its affiliates including Manulife Financial Corporation. This material is for informational purposes only. For more detailed information please contact your advisor. Manulife Financial or any of its agents, employees, or registered representatives do not give legal, tax, investment, or accounting advice. The information given here is merely a summary of our understanding of the current laws andregulations. Prospective purchasers should consult their tax advisor.The End.FOR BROKER/DEALER AND GENERAL AGENT USE ONLY.