An employer arranges for a life insurance policy on a key executive and agrees to pay the executive supplemental income beginning at retirement. The employer keeps the policy and uses its accumulated values to fund the promised retirement payments. This business arrangement is best described as:

Why A is correct

Deferred compensation is an arrangement in which an employer promises to pay an executive income at a future date, usually retirement, in exchange for current services, and uses a life insurance policy on the executive to accumulate the funds. The employer owns the policy and is the beneficiary. Premium payments are generally not currently deductible to the employer, but the deferred amounts are deductible when actually paid to the executive.

Why the other options are wrong

• B) Key person insurance protects the employer against the financial loss caused by the death of a valuable employee; the death benefit goes to the employer, not to fund retirement income.
• C) Buy-sell funding provides the money for the remaining owners to buy out a deceased owner's interest, a very different purpose from retirement income.
• D) Salary continuation usually pays income to the executive's family after death, not supplemental retirement income to the executive while living.

Memory hook

Deferred comp = pay the executive later, at retirement. The life policy quietly builds the fund in the meantime.