A corporation wants to provide additional retirement income to key executives and owns life insurance policies on those executives to fund the promised future payments. 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 plan, the employer promises to pay an executive compensation in future years, typically after retirement, and often uses life insurance owned by the corporation to accumulate funds and provide the money needed to meet that obligation. Because the employer owns the policy, pays the premiums, and is the beneficiary, the arrangement is designed to fund the employer's future income obligation to the executive. The death benefit is not primarily intended to cover the employer's own loss but rather to supply the funds to pay the deferred compensation when it comes due.
Why the other options are wrong
- B) Key person coverage protects the business against financial loss caused by the death of a valuable employee; here the purpose is funding a future compensation obligation, not covering a business loss.
- C) Buy-sell funding ensures that surviving owners can purchase a deceased owner's interest; this scenario involves no transfer of ownership interest. No business interest changes hands here, so this funding technique is not a buy-sell arrangement.
- D) Split dollar involves sharing premium payments and benefits between the employer and the employee; here the corporation alone owns the policies and pays all premiums. There is no premium splitting or shared benefit between employer and employee in this scenario.
Memory hook
Deferred comp: employer keeps the policy to pay a promised future paycheck. Key person covers a loss, buy-sell funds a sale.