Business protection
Business continuation
Key employee coverage
Executive rewards
Split dollar plans
Deferred compensation
Business
continuation
What will your business do without you? Do you have an effective plan in
place to transfer ownership? A business continuation plan (often
referred to as a buy/sell agreement) is the most-effective way to transfer
ownership of a business interest after the death of an owner. Without
this key element in the planning process, the odds of the business
surviving the transfer are significantly reduced.
Life insurance as
funding vehicle
A buy/sell agreement specifies who will buy the
business, how much they will pay for it and other contingencies related to
the transfer. Without funding, however, the plan is not truly effective. A
life insurance policy—on the life of the owner—is a crucial element to
the successful transfer of the business interest. The tax-free death
benefit of the policy can be used by either the business or the surviving
owners (depending upon how the arrangement is set up legally) to purchase
the interest share from the estate of the deceased owner. Without this
money, the efforts to purchase the business share may not be successful.
Plan structure
A “stock redemption” or “entity” business
continuation plan has the business buying, owning and paying for life
insurance on the owner(s). Premium payments are not tax deductible to the
business, but the death benefit will be paid tax-free to the business
after the owner’s death. A “cross-purchase” plan has each of the
owners purchasing policies on each other. For example, Owner 1 purchases a
policy on Owner 2’s life, and makes all premium payments. Owner 1
receives the tax-free death benefit at Owner 2’s death and uses the
funds to purchase the business share from Owner 2’s estate.
The
insurance policy
Either Harleysville’s Elite Term or Pro Performer
universal life coverage—or a combination of both—can be used to meet
this business continuation plan funding need. Term insurance can meet a
tight budget constraint; universal life is ideal for accumulating cash
values for business use in the event an owner doesn’t die. Considering
both types of coverage gives you all the information you need to make an
informed choice.
Key employee coverage
Can your business survive the loss of a key employee? Key
employee coverage is designed to protect your business in the event of a
key employee’s untimely death. The death benefit of the policy provides
the cash needed to compensate the business for financial losses during the
transition. Employees can be considered “key” if their death would
have an impact on the profits of your business.
Life
insurance
While there are a number of ways that your business can
prepare for this need, life insurance is the most cost efficient. For
pennies on the dollar, a life insurance policy will provide full coverage
from day 1—preparing the business no matter when death occurs.
Coverage
amounts
A key employee policy is generally at least 5-7 times
the amount of the key employee’s salary. This provides the funds needed
to find, hire and train a replacement, as well as compensate your business
for the revenue lost during the transition to a fully functional new
employee.
The
insurance policy
Since the policy is for the protection of your
business, the policy is owned by, paid for by and payable to the business.
Premiums paid for the policy are not deductible, but death benefits
received are income-tax free to the business.
Term
vs. permanent
An Elite Term plan works best for pure protection for a
set number of years, ideal coverage for a key employee plan that does not
extend past the key employee’s retirement time. Term insurance could
also be called for up front due to cost considerations, since in many
cases initial term premiums are lower than for permanent plans such as the
Pro Performer universal life.
Executive rewards
Here’s a tax-deductible way to attract and retain key
employees to run your business. An executive bonus arrangement is designed to reward
key executives and tie them more closely to your business—making them
less likely to be lured away by one of your competitors, in other words.
This plan can be offered on a discriminatory basis; you, as the business
owner, determine participation in the program.
Life
insurance
The long-term nature of a cash value life insurance
policy supports the long-range goal of the bonus program. The business
applies for life insurance of the life of each participating executive,
with the executive’s full consent and participation. The business makes
its bonus payments directly to the insurance company as payment of the
premium due. The fact that the payment is going directly from the business
to the insurance company does not change the tax status of the bonus
payment, but does ensure that the funds will actually make it to the
insurance policy as payment, rather than being siphoned off for other,
less-effective uses.
Bonus
payments
While the actual life insurance needs of the executive
should be properly evaluated in this process, the amount of bonus is
generally either based on the amount of insurance being purchased, or the
reverse: the amount of insurance is determined based on a flat amount of
bonus being offered. The bonus payment, as long as it does not violate IRS
“reasonable compensation” guidelines, is deductible to the business.
As a result, it is included in the executive’s taxable wage base for
each year a bonus is paid.
The
insurance policy
Although the premiums are paid by the business, the
policy is owned by the executive—he/she names a personal beneficiary and
has control over the policy benefits. The tie to the business is
effectively strengthened since leaving the business would discontinue the
premium funding for the policy.
Split
dollar plans
Would you like your business to help you pay for
personal life insurance? Split dollar arrangements are an executive rewards program designed to channel
business dollars toward funding personal life insurance for owners and key
executives of a business. There are two types of plans: collateral
assignment and endorsement split dollar.
Endorsement
split dollar plans
The policy is owned by the business under an
endorsement split dollar plan. The business owns all cash value and rights
in the policy, and endorses over a portion or all of the death benefit to
the insured executive for personal coverage. The executive must report the
annual taxable value of the current life insurance protection earmarked
for personal coverage. As long as the executive does not have access to
any policy cash values, no further tax consequences generally apply.
At the termination of the arrangement—usually at
retirement time—the policy can be transferred to the employee based on
the surrender value. The business could also choose to retain the policy
or surrender it for its cash value at plan termination.
Collateral
assignment split dollar plans
Under this type of plan, the insured executive owns the
policy for personal coverage. The business contributes all or a portion of
the premium payments due in the form of a loan to the executive. The loan
interest is based on the AFR (applicable federal rate) in effect at the
time; premium dollars loaned are paid back at plan termination. Adverse
tax consequences will apply if the executive pays a less than fair market
value for the loaned dollars.
At the termination of the arrangement—usually at
retirement—the loaned dollars are paid back to the business, and the
policy is owned by the executive free and clear.
Deferred compensation
Do you need an effective “golden handcuffs” program
to retain key people? A deferred compensation arrangement is designed to reward key executives
and tie them more closely to the business—making them less likely to be
lured away by one of your competitors. It is a very effective “golden
handcuffs,” since generally no benefit is payable if an executive leaves
the employer prior to the conclusion of the agreement.
The
agreement
The terms of the deferred compensation arrangement
dictate the funding needs. Generally, the executive is promised a certain
amount of money for a specific number of years if he/she remains an
employee in good standing until that time. For example: the executive
could be promised $20,000/year for 10 years, starting at age 65, if he
stays with the business until then. If he leaves prior to age 65, he
generally receives nothing, so no benefit is vested until payments begin.
This avoids constructive receipt of the money for tax purposes. The
agreement may also specify that if the executive dies prior to retirement,
a surviving family member will receive full or partial payment as survivor
income—that’s why life insurance is the ideal funding vehicle for a
deferred compensation plan. This arrangement needs to be put into a formal written agreement
so each party clearly understands what will happen.
Source
of funds
Under a deferred compensation arrangement, current
dollars to invest today to create an income stream later can come from two
sources:
-
A portion of the executive’s current salary—No
current taxes are due on current salary that is deferred under a
deferred compensation arrangement. Taxes are due upon receipt of the
money in the future.
-
Additional business dollars earmarked for the executive’s benefit—Since
these dollars are channeled into a life insurance policy owned by the
employer, the executive does not have constructive receipt of the
money. Taxes are due at the time the money is received in the future.
Advantages
This type of “golden handcuffs” plan is very
effective at retaining key employees, since no benefit is vested until
payments are scheduled to begin, generally in retirement.
Ask
an agent
Your Harleysville
Life agent can help you with establishing an executive rewards program for
you or your key employees. Use our Find
agent feature or contact Harleysville Life directly at 800.222.1981 to
find an agent in your area.
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