An employer wants to fund a promise to pay an executive supplemental retirement income after the executive retires. Which life insurance arrangement is designed for this purpose?
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Deferred compensation is an arrangement in which an employer promises to pay an employee a specified income in the future, typically at retirement, as a supplement to retirement benefits. To fund that obligation, the employer commonly owns a life insurance policy on the executive's life, pays the premiums, and is the beneficiary. When the executive dies, the death proceeds help the employer meet the promised payments. This is a distinct business use of life insurance, separate from key person coverage or buy-sell funding, and it illustrates how life insurance can guarantee funds for future obligations.
Why the other options are wrong
- B) If the executive owns the policy and names the employer as beneficiary, the employer has no ownership control; deferred compensation funding is structured with the employer as owner. The arrangement described places ownership where it belongs in deferred compensation planning.
- C) A key person policy reimburses the employer for financial loss caused by the employee's death; it does not fund a promised future payment the employer owes the executive. Instead, the coverage exists to pay the executive's promised benefit, not to compensate the employer for a loss.
- D) A buy-sell agreement funds the purchase of a deceased owner's interest in the business; it is not used to fund an executive's supplemental retirement income. The purchase of the executive's interest is a separate transaction outside this plan.
Memory hook
Employer funds a future promise, so the employer owns the policy. Promise money = deferred comp.