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Using a loan-based split dollar technique, the following plans are discussed in this presentation: Leveraged Executive Bonus Leveraged Deferred Compensation*

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Presentation on theme: "Using a loan-based split dollar technique, the following plans are discussed in this presentation: Leveraged Executive Bonus Leveraged Deferred Compensation*"— Presentation transcript:

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2 Using a loan-based split dollar technique, the following plans are discussed in this presentation: Leveraged Executive Bonus Leveraged Deferred Compensation* Leveraged 401(k) Look-A-Like* Background Details * These two illustrations are basically the same; however, they have different presentation titles for those who want to direct the presentation to firms and executives considering deferred compensation or those involved in 401(k) plans who are interested in supplements beyond current contribution limits.

3 Each of the three benefit arrangements involves executive-owned life insurance policies in which the employer either: 1) bonuses the premium for the policy and provides a loan for the income tax on the bonus or 2) loans the executive the premiums for a life insurance policy. The policy benefits are divided with the employer entitled to a portion of the death benefit and cash values equal to its loan advances. The executive (or his/her family) is entitled to the balance. Note: Each of the three plans is structured to be in compliance with the Final Split Dollar Regulations issued in September Background Details

4 The employer typically bonuses the executive an amount to cover the loan interest and, in many cases, a “gross-up” bonus is used which includes sufficient funds to pay the income tax on the bonus. Background Details Interest rates on the term loans associated with these plans are typically set to the long-term Applicable Federal Rate established under IRC Sections 7872(f)(2)(A) and 1274(d).

5 Generally, the loans are long-term loans (greater than nine years), although mid-term loans (over three years but not over nine years) or short-term loans (three years or less) can be used. Demand loans with annually changing interest rates can also be used; however, in most cases, term loans are preferred since interest rates can be tied down for longer periods of time, e.g., loan durations of 20 years or more at known interest rates can easily be accommodated. Background Details So long as the loan interest rate that is paid by the executive equals or exceeds the selected Applicable Federal Rate, no further loan interest is imputed by the IRS on the transaction.

6 If, however, the loans are interest-bearing term loans with loan interest at or above the Applicable Federal Rate, the OID rules do not apply -- and the advantage of locking down favorable loan interest rates for long periods of time can be achieved without OID penalty. Background Details Some commentators have made the global recommendation that term loans be avoided. In the case of below-market term loans, this is good advice -- due to the imposition of the Original Issue Discount (“OID”) rules of IRC Sections on such loans.

7 Leveraged Compensation System Main Menu PMO = Profit-making Organization TEO = Tax Exempt Organization Other InsMark Concepts Involving Financing (3 slides). Important Notice, Circular Disclosure 230, Copyright & Trademark Notices (5 slides). Frequently Asked Questions (12 slides). Case Study 1a (PMO): Leveraged Executive Bonus (7 slides) Case Study 1b (TEO): Leveraged Executive Bonus (7 slides) Case Study 2a (PMO): Leveraged Deferred Compensation (13 slides) Case Study 2b (TEO): Leveraged Deferred Compensation (13 slides) Case Study 3a (PMO): Leveraged 401(k) Look-A-Like (13 slides) Case Study 3b (TEO): Leveraged 401(k) Look-A-Like (13 slides) Return to Background Details (5 slides) Start from the beginning Plan Design Comments (5 slides).

8 Leveraged Compensation System Module: Leveraged Executive Bonus Case Study 1a (Profit-Making Organization) 7 slides

9 The employer pays a bonus to the covered executive equal to the policy premium coupled with a loan equal to the income tax on the bonus. Case Study #1a Leveraged Executive Bonus (Profit-Making Organization) Note: The assumed date of the illustration that follows is January 2010, the month in which the long-term Applicable Federal Rate was 4.11%. Click here to view a website with a history of Applicable Federal Rates.

10 Purpose of the Insurance: Family Protection / Retirement Income Insured: Arthur Lee (age 45) Policy Owner: Insured Beneficiary: Spouse and children Leveraged Executive Bonus Profit-Making Organization Type of Policy: Indexed Universal Life Face Amount: $2.5 million Premiums: $100,000 a year for 5 years Funding of Premium: Bonus from employer Funding of Income Tax on Bonus: Loan from employer Loan Interest Rate: 4.11% (funded by additional bonus from employer) Loan Repayment: At retirement (age 65) via policy withdrawal After Cash Flow at age 65: Policy loans of $135,000 a year for 20 years 1a.

11 Leveraged Executive Bonus Executive’s Summary of Costs and Benefits 1a. Executive’s cash-on-cash, pre-tax equivalent rate of return: 38.24%

12 Leveraged Executive Bonus Profit-Making Organization’s Summary of Costs 1a.

13 Review the reports for the plan sponsored by the Profit-Making Organization. Case Study #1a Leveraged Executive Bonus (Profit-Making Organization)

14 Licensees for Version 5.0 (or higher) of InsMark’s Leveraged Compensation System can review the menu input for the Leveraged Executive Bonus illustration featured in Case Study 1a by clicking on Sample Illustrations available from the Workbook Main Window. For licensing information regarding the Leveraged Compensation System, call InsMark at InsMark ( ). Institutional inquiries should be directed to David A. Grant, Senior Vice President - Sales, at or Analytical Resource Case Study 1a Leveraged Executive Bonus

15 Leveraged Compensation System Module: Leveraged Executive Bonus Case Study 1b (Tax Exempt Organization) 7 slides

16 The employer pays a bonus to the covered executive equal to the policy premium coupled with a loan equal to the income tax on the bonus. Case Study #1b Leveraged Executive Bonus (Tax Exempt Organization) Note: The assumed date of the illustration that follows is January 2010, the month in which the long-term Applicable Federal Rate was 4.11%. Click here to view a website with a history of Applicable Federal Rates.

17 Purpose of the Insurance: Family Protection / Retirement Income Insured: Robert Huntington (age 45) Policy Owner: Insured Beneficiary: Spouse and children Leveraged Executive Bonus Tax Exempt Organization Type of Policy: Indexed Universal Life Face Amount: $2.5 million Premiums: $100,000 a year for 5 years Funding of Premium: Bonus from employer Funding of Income Tax on Bonus: Loan from employer Loan Interest Rate: 4.11% (funded by additional bonus from employer) Loan Repayment: At retirement (age 65) via policy withdrawal After Cash Flow at age 65: Policy loans of $135,000 a year for 20 years 1b.

18 Leveraged Executive Bonus Executive’s Summary of Costs and Benefits 1b. Executive’s cash-on-cash, pre-tax equivalent rate of return: 38.24%

19 Leveraged Executive Bonus Tax Exempt Organization’s Summary of Costs Note: Net payments are higher than a Profit-Making Organization due to the absence of a deduction for the bonus. 1b.

20 Review the reports for the plan sponsored by the Tax Exempt Organization. Case Study #1b Leveraged Executive Bonus (Tax Exempt Organization)

21 Licensees for Version 5.0 (or higher) of InsMark’s Leveraged Compensation System can review the menu input for the Leveraged Executive Bonus illustration featured in Case Study 1b by clicking on Sample Illustrations available from the Workbook Main Window. For licensing information regarding the Leveraged Compensation System, call InsMark at InsMark ( ). Institutional inquiries should be directed to David A. Grant, Senior Vice President - Sales, at or Analytical Resource Case Study 1b Leveraged Executive Bonus

22 Leveraged Compensation System Module: Leveraged Deferred Compensation Case Study 2a (Profit-Making Organization) 13 slides

23 Case Study #2a Leveraged Deferred Compensation (Profit-Making Organization) This study examines the hypothetical case of Arthur Lee, age 45, an executive with Ryder Manufacturing Co., Inc. Arthur’s annual compensation is $500,000, and he is considering reducing it by $100,000 a year for five years. The evaluation that follows determines if this makes sense -- provided the employer funds a Leveraged Deferred Compensation arrangement with the compensation adjustment by loaning the executive $100,000 each year.

24 Case Study #2a Leveraged Deferred Compensation (Profit-Making Organization) With Leveraged Deferred Compensation, the executive reduces current compensation (or declines a planned increase), and the employer loans the executive an amount equal to the gross compensation reduction. Executive: The key to the transaction is the executive trades taxable compensation for a tax free capital item (the loan) which is used to fund a split dollar arrangement. Employer: The company retains the unpaid compensation, plus it carries a secured loan receivable on its books.

25 Case Study #2a Leveraged Deferred Compensation (Profit-Making Organization) Note: The assumed date of the illustration that follows is January 2010, the month in which the long-term Applicable Federal Rate was 4.11%. Click here to view a website with a history of Applicable Federal Rates.

26 plus Loan note: 100,000 Cash and Loan note: 566, Before the $100,000 Compensation Adjustment Employer’s Cash: $500,000 Follow the math in Year 1 for a hypothetical Profit-Making Organization in a 34% tax bracket. Note: This is repeated each year of premium payment. As you will see in the illustration, loan interest adjusts the gain in assets. 3. After Comp. Adjustment and Loan to Executive Cash: $566,000 less loan to exec: (100,000) Cash: $466,000 Initial Cash (Step 1): (500,000) Gain in assets: $ 66, After $100,000 Compensation Adjustment Prior cash: $500,000 plus retained Comp: 100,000 less income tax*: (34,000) Cash: $566,000 *on retained comp 2a.

27 Plan Sponsor: Ryder Manufacturing Co., Inc. Purpose of the Insurance: Family Protection / Retirement Income Insured: Arthur Lee (age 45) Policy Owner: Insured Beneficiary: Spouse and children Type of Policy: Indexed Universal Life Face Amount: $2.5 million Premiums: $100,000 a year for 5 years Funding of Premium: Compensation adjustment and loan from employer Funding of Income Tax on Bonus: Gross-up bonus from employer Loan Interest Rate: 4.11% Loan Repayment: At retirement (age 65) via policy withdrawal After Tax Retirement Cash Flow at age 65: $100,000 a year for 20 years Leveraged Deferred Compensation Profit-Making Organization 2a.

28 Leveraged Deferred Compensation Executive’s Summary of Costs and Benefits 2a. Executive’s cash-on-cash, pre-tax equivalent rate of return: 14.74%

29 Leveraged Executive Bonus Profit-Making Organization’s Summary of Costs Note the permanent, long-range, negative, charge to earnings of $ -167,244. (A negative charge to earnings is a credit to earnings.) 2a.

30 Review the reports for the plan sponsored by the Profit-Making Organization. Case Study #2a Leveraged Deferred Compensation (Profit-Making Organization)

31 Query: Could Arthur have used the $60,000 a year for five years in more efficient manner? Case Study #2a Alternatives for Arthur Lee The Leveraged Deferred Compensation arrangement has been funded by way of a compensation adjustment of $100,000 a year for five years resulting in a net after tax compensation loss of to Arthur of $60,000 for each of those five years (in his 40% marginal income tax bracket). Let’s consider a hypothetical equity alternative.

32 Case Study #2a Summary of the Alternatives for Arthur Lee Equity Account Yield: 7.50% growth; 1.00% div. Mgt. fee: 1.00%; Turnover: 50% Arthur’s cost: $60,000 a year for 5 years Retirement 65 Desired after tax cash flow: $100,000 Results: $100,000 a year lasting for 8 years; then $77,770 for 1 year with $0 remaining balance thereafter. Indexed UL Face amount: $2,500,000 Interest assumption: 8.50% Arthur’s cost: $60,000 a year for 5 years Retirement 65 Desired after tax cash flow: $100,000 Results: $100,000 a year lasting for 20 years with $2,390,812 remaining death benefit with cash value of $2,091,285. Full details of the Equity Account are available on the following slide.

33 Click here to review the year-by-year results if Arthur were take the $100,000 of compensation for five years and invest the resulting $60,000 a year in a hypothetical equity account. Case Study #2a Details of the Equity Alternative for Arthur Lee

34 Licensees for Version 5.0 (or higher) of InsMark’s Leveraged Compensation System can review the menu input for the Leveraged Executive Bonus illustration featured in Case Study 2a by clicking on Sample Illustrations available from the Workbook Main Window. For licensing information regarding the Leveraged Compensation System, call InsMark at InsMark ( ). Institutional inquiries should be directed to David A. Grant, Senior Vice President - Sales, at or Analytical Resource Case Study 2a Leveraged Executive Bonus Licensees for Version 15.1 (or higher) of the InsMark Illustration System can review the menu input for the Equity calculations in Case Study 2a by clicking on the file below (see Arthur Lee): Equity Calculations for LCP.!II

35 Leveraged Compensation System Module: Leveraged Deferred Compensation Case Study 2b (Tax Exempt Organization) 13 slides

36 With Leveraged Deferred Compensation, the executive reduces current compensation (or declines a planned increase), and the employer loans the executive an amount equal to the gross compensation reduction. Executive: The key to the transaction is the executive trades taxable compensation for a tax free capital item (the loan) which is used to fund a split dollar arrangement. Employer: The company retains the unpaid compensation, plus it carries a secured loan receivable on its books. Case Study #2b Leveraged Deferred Compensation (Tax Exempt Organization)

37 Case Study #2b Leveraged Deferred Compensation (Tax Exempt Organization) This study examines the hypothetical case of Robert Huntington, age 45, an executive with Bay Area Medical Center. Robert’s annual compensation is $500,000, and he is considering reducing it by $100,000 a year for five years. The evaluation that follows determines if this makes sense -- provided the employer funds a Leveraged Deferred Compensation arrangement with the compensation adjustment by loaning the executive $100,000 each year.

38 Case Study #2b Leveraged Deferred Compensation (Tax Exempt Organization) Click here to view a website with a history of Applicable Federal Rates. Note: The assumed date of the illustration that follows is January 2010, the month in which the long-term Applicable Federal Rate was 4.11%.

39 Follow the math in Year 1 for a hypothetical Tax Exempt Organization in a 0% tax bracket. plus Loan note: 100,000 Cash and Loan note: 600, Before the $100,000 Compensation Adjustment Employer’s Cash: $500,000 Note: This is repeated each year of premium payment. As you will see in the illustration, loan interest adjusts the gain in assets. 3. After Comp. Adjustment and Loan to Executive Cash: $600,000 less loan to exec: (100,000) Cash: $500,000 Initial Cash (Step 1): (500,000) Gain in assets: $100, After $100,000 Compensation Adjustment Prior cash: $500,000 plus retained Comp: 100,000 less income tax*: (0) Cash: $600,000 *on retained comp 2b.

40 Plan Sponsor: Bay Area Medical Center Purpose of the Insurance: Family Protection / Retirement Income Insured: Robert Huntington (age 45) Policy Owner: Insured Beneficiary: Spouse and children Type of Policy: Indexed Universal Life Face Amount: $2.5 million Premiums: $100,000 a year for 5 years Funding of Premium: Compensation adjustment and loan from employer Funding of Income Tax on Bonus: Gross-up bonus from employer Loan Interest Rate: 4.11% Loan Repayment: At retirement (age 65) via policy withdrawal After Tax Retirement Cash Flow at age 65: $100,000 a year for 20 years Leveraged Deferred Compensation Tax Exempt Organization 2b.

41 Leveraged Deferred Compensation Executive’s Summary of Costs and Benefits 2b. Executive’s cash-on-cash, pre-tax equivalent rate of return: 14.74%

42 Leveraged Executive Bonus Tax Exempt Organization’s Summary of Costs Note the permanent, long-range, negative, charge to earnings of $ -253,400. (A negative charge to earnings is a credit to earnings.) 2b.

43 Review the reports for the plan sponsored by the Tax Exempt Organization. Case Study #2b Leveraged Deferred Compensation (Tax Exempt Organization)

44 Case Study #2b Alternatives for Robert Huntington The Leveraged Deferred Compensation arrangement has been funded by way of a compensation adjustment of $100,000 a year for five years resulting in a net after tax compensation loss to Robert of $60,000 for each of those five years (in his 40% marginal income tax bracket). Query: Could Robert have used the $60,000 a year for five years in more efficient manner? Let’s consider a hypothetical equity alternative.

45 Case Study #2b Summary of the Alternatives for Robert Huntington Equity Account Yield: 7.50% growth; 1.00% div. Mgt. fee: 1.00%; Turnover: 50% Arthur’s cost: $60,000 a year for 5 years Retirement 65 Desired after tax cash flow: $100,000 Results: $100,000 a year lasting for 8 years; then $77,770 for 1 year with $0 remaining balance thereafter. Indexed UL Face amount: $2,500,000 Interest assumption: 8.50% Arthur’s cost: $60,000 a year for 5 years Retirement 65 Desired after tax cash flow: $100,000 Results: $100,000 a year lasting for 20 years with $2,390,812 remaining death benefit with cash value of $2,091,285. Full details of the Equity Account are available on the following slide.

46 Click here to review the year-by-year results if Robert were to take the $100,000 of compensation for five years and invest the resulting $60,000 a year in a hypothetical equity account. Case Study #2b Details of the Equity Alternative for Robert Huntington

47 Licensees for Version 5.0 (or higher) of InsMark’s Leveraged Compensation System can review the menu input for the Leveraged Executive Bonus illustration featured in Case Study 2b by clicking on Sample Illustrations available from the Workbook Main Window. For licensing information regarding the Leveraged Compensation System, call InsMark at InsMark ( ). Institutional inquiries should be directed to David A. Grant, Senior Vice President - Sales, at or Analytical Resource Case Study 2b Leveraged Executive Bonus Licensees for Version 15.1 (or higher) of the InsMark Illustration System can review the menu input for the Equity calculations in Case Study 2b by clicking on the file below (see Robert Huntington): Equity Calculations for LCP.!II

48 Leveraged Compensation System Module: Leveraged 401(k) Look-A-Like Case Study 3a (Profit-Making Organization) 13 slides

49 Case Study #3a Leveraged 401(k) Look-A-Like (Profit-Making Organization) With Leveraged 401(k) Look-A-Like, the executive reduces current compensation (or declines a planned increase), and the employer loans the executive an amount equal to the gross compensation reduction. Executive: The key to the transaction is the executive trades taxable compensation for a tax free capital item (the loan) which is used to fund a split dollar arrangement. Employer: The company retains the unpaid compensation, plus it carries a secured loan receivable on its books.

50 Case Study #3a Leveraged 401(k) Look-A-Like (Profit-Making Organization) This study examines the hypothetical case of Arthur Lee, age 45, an executive with Ryder Manufacturing Co., Inc. Arthur’s annual compensation is $500,000, and he is considering reducing it by $100,000 a year for five years. The evaluation that follows determines if this makes sense -- provided the employer funds a Leveraged 401(k) Look-A-Like arrangement with the compensation adjustment by loaning the executive $100,000 each year.

51 Case Study #3a Leveraged 401(k) Look-A-Like (Profit-Making Organization) Click here to view a website with a history of Applicable Federal Rates. Note: The assumed date of the illustration that follows is January 2010, the month in which the long-term Applicable Federal Rate was 4.11%.

52 plus Loan note: 100,000 Cash and Loan note: 566, Before the $100,000 Compensation Adjustment Employer’s Cash: $500,000 Follow the math in Year 1 for a hypothetical Profit-Making Organization in a 34% tax bracket. Note: This is repeated each year of premium payment. As you will see in the illustration, loan interest adjusts the gain in assets. 3. After Comp. Adjustment and Loan to Executive Cash: $566,000 less loan to exec: (100,000) Cash: $466,000 Initial Cash (Step 1): (500,000) Gain in assets: $ 66, After $100,000 Compensation Adjustment Prior cash: $500,000 plus retained Comp: 100,000 less income tax*: (34,000) Cash: $566,000 *on retained comp 3a.

53 Plan Sponsor: Ryder Manufacturing Co., Inc. Purpose of the Insurance: Family Protection / Retirement Income Insured: Arthur Lee (age 45) Policy Owner: Insured Beneficiary: Spouse and children Type of Policy: Indexed Universal Life Face Amount: $2.5 million Premiums: $100,000 a year for 5 years Funding of Premium: Compensation adjustment and loan from employer Funding of Income Tax on Bonus: Gross-up bonus from employer Loan Interest Rate: 4.11% Loan Repayment: At retirement (age 65) via policy withdrawal After Tax Retirement Cash Flow at age 65: $100,000 a year for 20 years Leveraged 401(k) Look-A-Like Profit-Making Organization 3a.

54 Leveraged 401(k) Look-A-Like Executive’s Summary of Costs and Benefits 3a. Executive’s cash-on-cash, pre-tax equivalent rate of return: 14.74%

55 Leveraged 401(k) Look-A-Like Profit-Making Organization’s Summary of Costs Note the permanent, long-range, negative, charge to earnings of $ -167,244. (A negative charge to earnings is a credit to earnings.) 3a.

56 Review the reports for the plan sponsored by the Profit-Making Organization. Case Study #3a Leveraged 401(k) Look-A-Like (Profit-Making Organization) For a look at an impressive variation called Deductible Roth 401(k) Look-A-Like, go to: https://www.insmarkstore.com/registry/PDFs/MA230.pdf

57 Query: Could Arthur have used the $60,000 a year for five years in more efficient manner. Case Study #3a Alternatives for Arthur Lee The Leveraged 401(k) Look-A-Like arrangement has been funded by way of a compensation adjustment of $100,000 a year for five years resulting in a net after tax compensation loss of to Arthur of $60,000 for each of those five years (in his 40% marginal income tax bracket). Let’s consider a hypothetical equity alternative.

58 Case Study #3a Summary of the Alternatives for Arthur Lee Equity Account Yield: 7.50% growth; 1.00% div. Mgt. fee: 1.00%; Turnover: 50% Arthur’s cost: $60,000 a year for 5 years Retirement 65 Desired after tax cash flow: $100,000 Results: $100,000 a year lasting for 8 years; then $77,770 for 1 year with $0 remaining balance thereafter. Indexed UL Face Amount: $2,500,000 Interest assumption: 8.50% Arthur’s cost: $60,000 a year for 5 years Retirement 65 Desired after tax cash flow: $100,000 Results: $100,000 a year lasting for 20 years with $2,390,812 remaining death benefit with cash value of $2,091,285. Full details of the Equity Account are available on the following slide.

59 Click here to review the year-by-year results if Arthur were take the $100,000 of compensation for five years and invest the resulting $60,000 a year in a hypothetical equity account. Case Study #3a Details of the Equity Alternative for Arthur Lee

60 Licensees for Version 5.0 (or higher) of InsMark’s Leveraged Compensation System can review the menu input for the Leveraged Executive Bonus illustration featured in Case Study 3a by clicking on Sample Illustrations available from the Workbook Main Window. For licensing information regarding the Leveraged Compensation System, call InsMark at InsMark ( ). Institutional inquiries should be directed to David A. Grant, Senior Vice President - Sales, at or Analytical Resource Case Study 3a Leveraged Executive Bonus Licensees for Version 15.1 (or higher) of the InsMark Illustration System can review the menu input for the Equity calculations in Case Study 3a by clicking on the file below (see Arthur Lee): Equity Calculations for LCP.!II

61 Leveraged Compensation System Module: Leveraged 401(k) Look-A-Like Case Study 3b (Tax Exempt Organization) 13 slides

62 With Leveraged 401(k) Look-A-Like, the executive reduces current compensation (or declines a planned increase), and the employer loans the executive an amount equal to the gross compensation reduction. Executive: The key to the transaction is the executive trades taxable compensation for a tax free capital item (the loan) which is used to fund a split dollar arrangement. Employer: The company retains the unpaid compensation, plus it carries a secured loan receivable on its books. Case Study #3b Leveraged 401(k) Look-A-Like (Tax Exempt Organization)

63 Case Study #3b Leveraged 401(k) Look-A-Like (Tax Exempt Organization) This study examines the hypothetical case of Robert Huntington, age 45, an executive with Bay Area Medical Center. Robert’s annual compensation is $500,000, and he is considering reducing it by $100,000 a year for five years. The evaluation that follows determines if this makes sense -- provided the employer funds a Leveraged Deferred Compensation arrangement with the compensation adjustment by loaning the executive $100,000 each year.

64 Case Study #3b Leveraged 401(k) Look-A-Like (Tax Exempt Organization) Click here to view a website with a history of Applicable Federal Rates. Note: The assumed date of the illustration that follows is January 2010, the month in which the long-term Applicable Federal Rate was 4.11%.

65 Follow the math in Year 1 for a hypothetical Tax Exempt Organization in a 0% tax bracket. plus Loan note: 100,000 Cash and Loan note: 600, Before the $100,000 Compensation Adjustment Employer’s Cash: $500,000 Note: This is repeated each year of premium payment. As you will see in the illustration, loan interest adjusts the gain in assets. 3. After Comp. Adjustment and Loan to Executive Cash: $600,000 less loan to exec: (100,000) Cash: $500,000 Initial Cash (Step 1): (500,000) Gain in assets: $100, After $100,000 Compensation Adjustment Prior cash: $500,000 plus retained Comp: 100,000 less income tax*: (0) Cash: $600,000 *on retained comp 3b.

66 Plan Sponsor: Bay Area Medical Center Purpose of the Insurance: Family Protection / Retirement Income Insured: Robert Huntington (age 45) Policy Owner: Insured; Beneficiary: Spouse and children Type of Policy: Indexed Universal Life Face Amount: $2.5 million Premiums: $100,000 a year for 5 years Funding of Premium: Compensation adjustment and loan from employer Funding of Income Tax on Bonus: Gross-up bonus from employer Loan Interest Rate: 4.11% Loan Repayment: At retirement (age 65) via policy withdrawal After Tax Retirement Cash Flow at age 65: $100,000 a year for 20 years Leveraged 401(k) Look-A-Like Tax Exempt Organization 3b.

67 Leveraged 401(k) Look-A-Like Executive’s Summary of Costs and Benefits 3b. Executive’s cash-on-cash, pre-tax equivalent rate of return: 14.74%

68 Leveraged 401(k) Look-A-Like Tax Exempt Organization’s Summary of Costs Note the permanent, long-range, negative, charge to earnings of $ -253,400. (A negative charge to earnings is a credit to earnings.) 3b.

69 Review the reports for the plan sponsored by the Tax Exempt Organization. Case Study #3b Leveraged 401(k) Look-A-Like (Tax Exempt Organization) For a look at an impressive variation called Deductible Roth 401(k) Look-A-Like, go to: https://www.insmarkstore.com/registry/PDFs/MA230.pdf

70 Query: Could Robert have used the $60,000 a year for five years in more efficient manner? Case Study #3b Alternatives for Robert Huntington The Leveraged Deferred Compensation arrangement has been funded by way of a compensation adjustment of $100,000 a year for five years resulting in a net after tax compensation loss to Robert of $60,000 for each of those five years (in his 40% marginal income tax bracket). Let’s consider a hypothetical equity alternative.

71 Case Study #3b Summary of the Alternatives for Robert Huntington Equity Account Yield: 7.50% growth; 1.00% div. Mgt. fee: 1.00%; Turnover: 50% Arthur’s cost: $60,000 a year for 5 years Retirement 65 Desired after tax cash flow: $100,000 Results: $100,000 a year lasting for 8 years; then $77,770 for 1 year with $0 remaining balance thereafter. Indexed UL Face amount: $2,500,000 Interest assumption: 8.50% Arthur’s cost: $60,000 a year for 5 years Retirement 65 Desired after tax cash flow: $100,000 Results: $100,000 a year lasting for 20 years with $2,390,812 remaining death benefit with cash value of $2,091,285. Full details of the Equity Account are available on the following slide.

72 Click here to review the year-by-year results if Robert were to take the $100,000 of compensation for five years and invest the resulting $60,000 a year in a hypothetical equity account. Case Study #3b Details of the Equity Alternative for Robert Huntington

73 Licensees for Version 5.0 (or higher) of InsMark’s Leveraged Compensation System can review the menu input for the Leveraged Executive Bonus illustration featured in Case Study 3b by clicking on Sample Illustrations available from the Workbook Main Window. For licensing information regarding the Leveraged Compensation System, call InsMark at InsMark ( ). Institutional inquiries should be directed to David A. Grant, Senior Vice President - Sales, at or Analytical Resource Case Study 3b Leveraged Executive Bonus Licensees for Version 15.1 (or higher) of the InsMark Illustration System can review the menu input for the Equity calculations in Case Study 3b by clicking on the file below (see Robert Huntington): Equity Calculations for LCP.!II

74 Leveraged Compensation System Plan Design Comments 5 slides

75 On plans with a series of annual loans, the interest rate on new loans must bear at least the appropriate rate in effect during the month each new loan is executed. This introduces an “unknown” into the concept which needs clarification. All the illustrations in this presentation use a constant Long-Term Applicable Federal Rate (“AFR”) for the loans associated with the split dollar component. Plan Design Comments Main Menu Click here to view a website with a history of Applicable Federal Rates.

76 There are four ways to deal with unknown future AFRs: 1. If a bonus is paid to the executive to offset the loan interest, accept the risk. This may increase or decrease the amount of the bonus; however, the loan interest paid to the employer by the executive should provide a full or partial offset, as the case may be. 2. If the rate increases, pay the increase. The executive could also accrue the additional loan interest or withdraw funds from the policy to pay the additional interest. Continued on next slide... Plan Design Comments

77 There are four ways to deal with unknown future AFRs: 3. Renegotiate the loans. Wait until a time when the Applicable Federal Rate dips and recast the series of promissory notes into a new note at the reduced rate. 4. Change the design so all loans are consolidated at the inception of the plan. The loaned funds in excess of the dollars needed to pay the policy’s initial premium should be escrowed and used to pay the remaining stream of premiums (perhaps using a fixed period, single premium, immediate annuity).

78 When consolidating the loans into one year, do not utilize a modified endowment contract (“MEC”). When a MEC is assigned as collateral security for a loan, taxable income to the executive is likely produced to the extent of any gain in the contract. Plan Design Comments

79 Leveraged Compensation System Frequently Asked Questions 12 slides

80 What is the difference between Leveraged Deferred Compensation and Leveraged 401(k) Look-A-Like? Frequently Asked Questions These two illustrations are basically the same; however, they have different presentation titles for those who want to direct the presentation to firms and executives considering deferred compensation or those involved in 401(k) plans who are interested in supplements beyond current contribution limits.

81 Sample Illustrations (including menu input) for all the plans discussed in this presentation are available from the Workbook Main Window of Version 5.0 (and higher) of the Leveraged Compensation System. If you are not licensed for the Leveraged Compensation System, contact an InsMark Account Executive at InsMark ( ) for information. Institutional inquiries should be made to David A. Grant, Senior Vice President - Sales at or What illustration resources are available? Frequently Asked Questions

82 If the executive dies or employment ceases (including retirement), is the compensation adjustment recoverable? If the executive is employed by a profit-making organization, a separate severance agreement can handle the recovery of the compensation adjustment no matter why employment ceases. With a tax exempt organization, the severance must be restricted to involuntary termination (other than for cause) due to the requirements of IRC Section 457(f) requiring a substantial risk of forfeiture on deferred compensation arrangements associated with tax exempt organizations. (If the severance were unrestricted, IRC Section 457(f) would require including the amount of severance in the executive's income immediately.)

83 Can a severance benefit be illustrated in the InsMark Leveraged Compensation System? Yes. Frequently Asked Questions

84 Is plan documentation available? Specimen documents for Leveraged Executive Bonus are located in Version 19.0 (and higher) of InsMark’s Documents On A Disk ® and Documents On The Net™ in the Executive Bonus Plans section. (Use the specimen document entitled “Leveraged Executive Bonus (With Loan Regime Collateral Assignment Split Dollar to Pay Tax on Bonus)”. Specimen documents for Leveraged Deferred Compensation and Leveraged 401(k) Look-A-Like are in Version 19.0 (and higher) of Documents On A Disk® and Documents On The Net™ in the Employer-Sponsored Split Dollar Plans section. (Use the documents for Leveraged Deferred Compensation for either plan.) Frequently Asked Questions

85 Are there any excess compensation issues associated with any of the plans? Provided overall compensation is reasonable, this should not present a problem for plans associated with Profit-Making Organizations. Tax Exempt Organizations need to pay special attention to unreasonable compensation issues. Click here to review a report on excess compensation as it relates to Tax Exempt Organization.

86 Can publicly-owned companies use these plans? Due to provisions of Sarbanes-Oxley, Leveraged Executive Bonus, Leveraged Deferred Compensation, and Leveraged 401(k) Look-A-Like are not appropriate for executives of public corporations. Premium financing from an independent source such as a bank could be appropriate. (See InsMark’s Premium Financing System.) Frequently Asked Questions

87 Are these plans competitive with other executive fringe benefits? One of the unusual features of these plans is the production of tax free retirement cash flow through policy loans. Other fringe benefits (e.g., salary continuation, deferred compensation, stock options) lack this characteristic. The other unique feature is that any size employer can utilize these plans. The alternatives mentioned above are usually effective only when sponsored by sizable employers. Frequently Asked Questions

88 What type of policy should be used with these plans? The concepts work with any cash value policy -- whole life, universal life, indexed universal life, variable universal life, and variable life. Frequently Asked Questions

89 When must loans associated with these plans be repaid to the employer? The specimen promissory note provided with the System typically calls for the note to be repaid at the end of a specified term of years agreeable to the parties or at the prior death of the insured. Source of funds: The executive usually has the option of repaying the loans by using a loan on the policy. The System can also illustrate the repayment of loans from funds bonused by the employer. Frequently, this involves a single bonus with the executive borrowing funds from the policy to pay the tax on the bonus (a gross-up bonus can also be illustrated). Frequently Asked Questions

90 What are the details of renegotiating the loans associated with Loan-Based Deferred Compensation in order to take advantage of reduced Applicable Federal Rates that might occur in the future? Click here to review a report on this subject. Frequently Asked Questions

91 3 slides Other InsMark Concepts Involving Financing Premium Financing SystemLoan-Based Split Dollar System

92 This System illustrates third-party financed life insurance owned by an individual, a company, or an irrevocable life insurance trust. It also includes an illustration module in which the income tax on an executive bonus (used to purchase life insurance) is funded via third- party financing. Data from InsMark’s premium financing illustrations can be imported into InsMark’s Wealthy and Wise ® System where it can be compared using “don’t-do-it” versus “do-it” logic. Rather than presenting a premium financing illustration as an isolated transaction, by comparing its impact on Net Worth and Wealth to Heirs, clients can review an integrated analysis of its powerful results. Other InsMark Concepts Involving Financing InsMark Premium Financing System Continued on the next slide...

93 For licensing information about the Systems noted on this and the prior slide, contact an InsMark Account Executive at 888-InsMark ( ). Institutional inquires should be directed to David A. Grant, Senior Vice President - Sales, at or Other InsMark Concepts Involving Financing InsMark Loan-Based Split Dollar System Loan-Based Split Dollar and Loan-Based Private Split Dollar illustrations are available in this System. Note: Data from both illustrations can be exported to InsMark’s Wealthy and Wise ® System. Note: With the significant increases in income taxes expected for individuals, all forms of loan-based split dollar will likely become preferred executive benefits.

94 Leveraged Compensation System Important Notice, Circular Disclosure 230, Copyright and Trademark Notices 5 slides

95 Important Notice Examples and case studies in this presentation are for illustration purposes, and actual results may vary. Legal and tax information is for general use only and may not be applicable to specific circumstances. Clients should consult their own legal, tax and accounting advisors to assist in the evaluation of any of the concepts outlined in this presentation. Policy loans reduce cash values and death benefits. The lapse of a loaned policy could result in severe tax ramifications to the policy owner. Be sure to consult your professional tax adviser if you have any questions about this issue.

96 Circular 230 Disclosure In order to comply with requirements imposed by the IRS which may apply to this presentation (including any attachments, enclosures, or referred material) as distributed or as re-circulated, please be advised that the material contained herein is not intended or written to be used, and it cannot be used, by anyone for the purposes of avoiding any penalty that may be imposed by the Internal Revenue Service under the Internal Revenue Code.

97 Circular 230 Disclosure - continued In the event that this presentation (including any attachments, enclosures, or referred material) is also considered to be a “marketed opinion” within the meaning of the IRS guidance, then, as required by the IRS, please be further advised that the material contained herein is written to support the promotions or marketing of the transactions or matters addressed by the material contained herein, and, based on the particular circumstances, you should seek advice from an independent tax advisor.

98 Click here to start from the beginning. © Copyright , InsMark, Inc. All Rights Reserved Click here to return to the Main Menu. “InsMark” is a registered trademark of InsMark, Inc.


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