A business promises an executive retirement benefits and uses life insurance to fund the promise. The employer owns the policy, pays the premiums, and is the beneficiary; at retirement the employer uses the policy values to pay the executive. This arrangement is best described as:

Why A is correct

In a deferred compensation arrangement the employer promises to pay benefits in the future, typically at retirement, and life insurance on the executive is used to accumulate funds. The employer owns the policy and is the beneficiary; premiums are not currently deductible, but the benefits paid to the executive become deductible compensation when actually paid. This nonqualified arrangement is used to retain and reward key talent without running afoul of qualified plan contribution limits. Unlike key-person coverage, the funds are earmarked to pay benefits to the executive rather than to indemnify the company for a financial loss caused by the executive's death.

Why the other options are wrong

• B) Key-person insurance indemnifies the business for the financial loss caused by a vital employee's death; the company keeps the proceeds and uses them for its own recovery, not for retirement benefits to the employee. Here the funds are directed to the executive, which is a deferred compensation design.
• C) Buy-sell funding provides cash for surviving owners to purchase a deceased owner's business interest, which is a different purpose from funding future benefits for a living executive. The proceeds are used to buy out ownership, not to fund retirement promises.
• D) The instant estate concept describes the immediate creation of a death benefit estate at the insured's death, not the accumulation of funds to pay retirement benefits to a living employee. This arrangement funds a living benefit promise, not an estate at death.

Memory hook

Deferred comp: company saves today with insurance, pays the executive tomorrow, deducts when paid.