An employer promises to pay a key executive a set sum at retirement and funds that future obligation with life insurance it owns on the executive. This business use of life insurance is best described as:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
In a deferred compensation arrangement the employer promises to pay an executive compensation at a later date — usually retirement — and uses life insurance on the executive to fund the obligation. Because the employer is the owner and beneficiary, the death benefit funds the promised amounts if the executive dies first, and the cash values help fund the payout at retirement. The executive is not taxed on the deferred amount until it is actually paid, and the employer generally takes no deduction until payment. The structure keeps the executive in the company and defers the tax cost of the compensation.
Why the other options are wrong
- B) Business overhead expense insurance pays the firm's fixed operating expenses if a key owner becomes disabled — not a retirement benefit for an executive.
- C) An executive bonus plan pays premiums on an employee-owned policy that the employee controls; in deferred compensation the employer owns the contract and controls the benefit.
- D) Estate conservation uses life insurance to create liquidity for estate taxes at the owner's death — a personal planning goal, not an employer retirement benefit.
Memory hook
Deferred comp = pay the executive later, fund it now with life insurance. Employer owns, employer collects, the promise gets funded.