Uses of Insurance and Annuities for Business and Retirement

Business Uses- the same policies that were used to offset mortality risk for individuals and families can be used for businesses as well. The function is an almost identical fashion.

Key Employee Life –

The lives of employees:

This is critical to the future success of the company because this is an insurable

interest. The employee must always give consent.

The business is the applicant or the owner and the beneficiary.

Tax Facts:

Premiums are not tax deductible and death benefits are not considered taxable income.

Business Continuation Plans

This allows the surviving partners or stockholders of a closely held corporation to purchase the interest of a deceased partner or shareholder. The rights of the surviving partners or shareholders are spelled out in a Buy-Sell Agreement.

There are two basic forms for this:

Stock Redemption Plan – The Corporation is purchasing the deceased principal’s share of the business. If the business is a partnership, it is called an Entity Plan.

Funding through insurance: The business buys policies on the lives of the principals. It can be done as separate policies or a single Joint life policy, which would pay when the first one dies.

Cross Purchase Plan – Each surviving principal buys a pro rata share of the deceased principal’s shares.

Funding through insurance: Each principle buys a policy on the lives of all the shareholders. An agreement covering three principals requires six policies.

Tax Facts:

Premiums are not tax deductible and death benefits are not considered taxable income.

Nonqualified Employee Benefits – there is no tax advantage for either the employer or the employee.

Split Dollar Plans – these plans the employer and the employee split both the premium and the death benefit.

Tax Facts:

The employee’s share is compensation and is taxed as income.

Deferred Compensation Plans – The promise to pay in the future for work done today.

Tax Facts:

The employee has no legal right to money until the payout begins which is usually after retirement.

Executive Bonus Plans are yearly bonuses to purchase Life insurance.

Tax Facts:

This type of bonus is compensation and is taxable.

Retirement Planning

Qualified verses Nonqualified Plans- Qualified plans are qualified for special tax treatment.

They must:

Be for the benefit of the employees and their beneficiaries

Be nondiscriminatory

Be in writing

Either define benefits or define contributions

Be a permanent plan

Meet minimum vesting standards

Vesting is ownership; qualified plans must vest within six years.

Overview: While each plan has its own special requirements, the pattern is almost universal. Whoever contributes the money does so in a tax advantaged way.

The employer will deduct as a business expense.

The employee either will deduct the contribution (IRA) or they will offset income (401k). Each of these plans has specific maximum contributions that can be made in a given year.

Note: Retirement accounts are invested in approved investment vehicles including Annuities but life insurance is not.

Tax Facts:

At retirement, any untaxed contributions and all interest are taxable. Minimum age for withdrawals is 59 ½ and must start by 70 ½. Early withdrawals are always taxed and generally subject to a 10% penalty.

Note: Roth IRAs are an exception because contributions are made with after tax money and proceeds are paid out tax-free. In fact, the 70 ½ rule does not apply to a Roth IRA.

Large Employer Plans

Two Types

Pension Plans require the employer to meet a contribution minimum in good years and in bad years.

Profit Sharing Plans require contributions only in years in which the company is making a profit.

Cash or Deferred Arrangement Plans (CODA)

This allows the employee to take a salary reduction or postpone a bonus in order to fund retirement. Sometimes the employer will match the employee’s contribution up to a certain percentage. These plans include the TSA OR 403-B plan which is for employees of 501C-3 (which is not for profit) organizations, the 401k plan and the Section 457 plan for employees of state and local governments as well as employees of not-for-profit entities.

Individual Plans

Anyone with an earned income can purchase an IRA.

The traditional IRA follows the normal pattern of retirement plans. Workers who have no other plan or earn below a specific annual salary can fully deduct their contributions. The account will accumulate on a tax-deferred basis until retirement.

Roth IRA contributions are not tax deductible, accumulate on a tax-free basis and distributions at retirement are not considered taxable income.

Both the IRA and the Roth IRA are individually funded they both vest immediately.

Small Employer Plans

Keogh for sole proprietorships and partnerships. Employees of these organizations must be included in the plan if twenty one years of age, one year on the job and working at least 1000 hours per year.

SEPs and SIMPLE plans simply provide a way for a small business employer to contribute to an employee’s IRA or 401k account and eliminate the responsibility for managing the retirement investments of their employees. The SEP resembles an employer sponsored IRA with higher limits. The SIMPLE plan resembles a 401k. The employee takes a salary reduction and the employer matches the employee’s contribution. Both of these plans vest immediately.

This is an optional quiz you may take to review the content of this unit.