Ask the Experts!
The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers. Here’s the question of the day.
Question: I have a business owner client who wants to reward a key employee with a life insurance-based benefit. What choices does the business owner have, and what are the relative advantages of each?
Answer: There are three main choices:
- Executive bonus plan
- Supplemental executive retirement plan (SERP)
- Split dollar plan
Under an executive bonus plan, the employer and the selected employee enter into an agreement under which the employer will pay the employee extra to cover the premium for a life insurance plan. The employer has the ability to pick and choose who among the employee group will be part of the plan.
A bonus plan generates a tax deduction for the business. However, the business gives up control of the coverage, and the employee must report the bonus amount as taxable income.
Under a SERP, the employer makes a promise to the employee to pay a cash benefit at a certain time in the future—perhaps the retirement of the employee, or the pre-retirement death of the employee. To informally fund its obligation, the employer owns insurance on the life of an employee. The employer is beneficiary of the policy and pays the non-deductible premium.
A SERP makes sense where the business owner wants to keep control of the life insurance policy for business reasons. A SERP can act as a kind of “golden handcuffs” on the employee—enticing the employee to stay with the company until the benefit is paid.
Under a split dollar plan, the employer and employer enter into an agreement regarding how the premium and policy benefits will be split. One simple method of splitting involves having the employer own the policy’s cash value, and the employee controls the policy’s death benefit in excess of the cash value.
While a split dollar plan does not generate an income tax deduction for the business, it does allow the business to recover some or all of the costs of the plan. Split dollar can also be beneficial for the employee, in that it usually has a lower out-of-pocket cost than buying personal coverage.
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