Overview of Life Insurance Strategies for the Small Business Owner*
Plan Type Plan Description
Supplemental Executive Retirement Planning (SERP)
Supplemental Executive Retirement Plans (SERPs) are used to provide both death protection and retirement income for yourself as a business owner and your key employees. SERPs are a kind of non-qualified deferred compensation plan and are often designed to supplement any qualified retirement plans which the business already has in place. The business itself is typically the owner and beneficiary of life insurance policies insuring the business owner(s) and other key talent in the organization. The business is not allowed an immediate deduction for premiums paid, but will take a deduction upon the payment of retirement income using policy cash values. The business will also typically receive death proceeds income tax free, but consideration should be given to the Pension Protection Act of 2006, which contains provisions impacting the income tax treatment of corporate owned death benefits. These provisions apply to corporate owned life insurance policies entered into after August 17, 2006. You should consult with your tax advisor as to how a SERP may be implemented in order to comply with these provisions. SERPs can be an excellent means to provide both death protection and supplemental retirement income. Corporate Corporation Company-paid supplemental retirement income and/or death benefits to designated beneficiaries No✝ Corporation Policy cash value provides a corporate asset which may be used to pay retirement benefits. Death benefit provides for cost recovery should the employee die in any given year. Yes Corporate resolution; plan document; DOL notification
401(K) Overlay
162 Bonus
Buy/Sell (Cross-Purchase Arrangement)
In a Cross-Purchase Arrangement, the business owners agree among themselves to purchase the business interest of a deceased owner. To fund the Cross-Purchase Arrangement, each business owner purchases, owns and is the beneficiary of life insurance policies insuring the lives of each of the other owners. In a properly structured Cross-Purchase Agreement, the death benefit can be received income tax-free and the surviving owners can receive a step-up in cost basis on the stock purchased from the deceased owner’s estate. Financial considerations to keep in mind include: Each owner must purchase a policy on the lives of the other owners. For example, a business with four owners would require 12 policies to effect a life insurance funded cross-purchase arrangement. Also, owners use personal funds to purchase the policies or use funds from the business entity through a bonus arrangement or a Split Dollar Arrangement. And premium payments are not tax-deductible to individuals or businesses.
Key Person
A properly designed 401(k) Overlay Plan is considered a non-qualified plan and therefore can only be “informally funded.” The employer makes an unsecured promise to pay additional income at some future time. Once the employer and employee enter into a legal contract describing the benefits, the employer may set aside assets to cover the future costs. The amount of benefits provided to a key executive must be considered reasonable compensation. The employee has the same rights to payment as a general unsecured creditor. There are a number of investment vehicles available to “informally fund” a 401(k) Overlay Plan. Some common funding vehicles provide growth, but as a taxable event to the business each year. Another choice is a variable universal life insurance policy that offers the potential for cash value accumulation on a tax-deferred basis. This type of policy provides a life insurance death benefit and exposure to equity markets through variable investment options. Most variable universal life insurance policies offer a wide selection of investment choices within the policy.
An executive bonus plan is a simple and tax deductible way for you to retain valuable executives and assist them with their supplemental retirement income needs. The employer pays a bonus or additional salary to select executives. The executive then purchases a life insurance policy on his/her life. Unlike other supplemental retirement plans, such as deferred compensation, your business gets a current income tax deduction for paying a bonus. The amount of benefits provided to a key executive must be within reasonable compensation guidelines. The business can also bonus the tax due on the executive’s bonus so there is reduced out of pocket cost to the executive. The executive-owned life insurance policy may provide supplemental retirement income through tax-advantaged withdrawals and loans** from the policy. Also, the executive’s beneficiaries may receive the policy death benefit income tax-free. The policy’s death benefit may be included in his/her estate for Federal estate tax purposes. Subject to any restrictions or endorsements agreed to by the employer and executive, the executive has all ownership rights in the policy.
Key person coverage can do more than simply protect your firm against financial loss. It can also help prevent attrition. The cash value in a life insurance policy can be used to informally fund a non-qualified deferred compensation plan for the key person. The insurance policy offers the potential for cash value accumulation on a tax-advantaged basis. A key person cannot have actual or constructive receipt of the income to be paid in the future. As a result, the key person agrees to defer a portion of his or her future income. He or she also forgoes any guarantee that the money will be paid in the future. Once the key person receives income from the plan, he or she pays income tax and the corporation receives a tax deduction for the distributions. Additionally, the plan qualifies for tax-advantaged treatment as long as the funds remain available to the company’s creditors in the event of insolvency. In general, the business owns both the life insurance policy and any cash value that accumulates. The cash value is available to the business at any time through tax-advantaged loans and withdrawals.**
Ownership Beneficiary Primary Objectives Current Tax to Participant Control of Policy Values
Corporate Corporation Voluntary income deferral, with tax-deferred growth; enhanced survivor benefits possible No✝ Corporation Policy cash value provides a corporate asset which may be used to pay retirement benefits. Death benefit provides for cost recovery should the employee die in any given year. Yes Corporate resolution; plan document; income deferral form; DOL notification
Individual Insured or third party owner Simplicity; portable benefit; executive control
Individual, business Individual, business Fair market value for stock; funding for continuity of business; estate planning No Partners business Policy death benefit funds purchase of stock by the business or buys out ownership in the estate of the deceased partner.
Corporate Corporation Provide tax-free income to offset loss of key person’s experience and skills No Corporation At the employee’s death the policy provides funds for loss of income and subsequent recruiting and retraining as well as recovery of the cost of premiums.
Yes Insured or third party Insurance policy, which contains the executive’s cash value and death benefit, is the benefit. The corporation is bonusing out the policy premium or the policy premium and taxes as W-2 compensation. Some Corporate Resolution
Use of Insurance Funding
Ongoing Plan Administration Documentation Required
No Corporate Resolution
No Corporate Resolution
Important Information Relating to All Concepts
Life insurance policies contain fees and expenses, including cost of insurance, administrative fees and premium loads, surrender charges and other charges or fees that may be incurred under the policy. Variable universal life insurance policies also have additional charges and fund operating expenses. The investment return and principal value of an investment will fluctuate so that when redeemed, they may be worth more or less than their original cost. Life insurance death benefits are generally paid federal income tax-free. * Under Section 101(j) of the Internal Revenue Code, the death benefit of an employer owned life insurance contract may not be completely federal income tax-free if certain notice and consent rules and other requirements are not fulfilled. In addition, death proceeds may be included in your estate for estate tax purposes. You should consult your tax advisor. ** Both loans and withdrawals from a permanent life insurance policy may be subject to penalties and fees and, along with any accrued loan interest, will reduce the policy’s Account Value and Death Benefit. Depending upon the performance of a VUL policy’s investment choices, the Account Value may be worth more or less than the original amount invested in the policy. Assuming a policy is not a Modified Endowment Contract (MEC), loans are free from current Federal taxation and withdrawals are taxed only to the extent that they exceed the policyowner’s basis in the policy. Distributions from MECs are subject to Federal income tax to the extent of the gain in the policy and taxable distributions are subject to a 10% additional tax, with certain exceptions.
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Assumes deferral of compensation under Plan is considered deferred for purposes of SEC 409A.
Important Information Relating to All Concepts This information is written in connection with the promotion or marketing of the matters addressed in this material. The information cannot be used or relied upon for the purpose of avoiding IRS penalties. These materials are not intended to provide tax, accounting or legal advice. As with all matters of a tax or legal nature, you should consult your own tax or legal counsel for advice. All guarantees within the life insurance policy are based on the claims-paying ability of the issuing insurance company. The Hartford is The Hartford Financial Services Group, Inc. and its subsidiaries, including the issuing companies of Hartford Life Insurance Company (New York) and Hartford Life and Annuity Insurance Company (Outside New York), Simsbury, CT. Variable universal life insurance is underwritten and distributed by Hartford Equity Sales Company, Inc., a broker/dealer affiliate of The Hartford. If you are considering the purchase of variable universal life insurance, you should carefully consider the investment objectives, risks, charges and expenses of the product and its underlying funds before investing. This and other information can be found in the prospectus for the variable universal life insurance policy and the underlying fund prospectuses, which can be obtained from your financial professional or by logging on to www.hartfordinvestor.com. Please read the prospectuses carefully before you invest or send money.
Overview of Life Insurance Strategies for the Small Business Owner
INSURANCE PRODUCTS: NOT INSURED BY FDIC OR ANY MAY LOSE NOT A DEPOSIT OF OR GUARANTEED FEDERAL GOVERNMENT AGENCY VALUE BY ANY BANK OR ANY BANK AFFILIATE FDIC BANK
LIF6640 LCM-06-1026-5-07