An employer promises an executive retirement benefits in the future and uses life insurance on the executive, with the employer as owner and beneficiary, to fund that obligation. This is an example of:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Deferred compensation is a business use of life insurance in which the employer promises to pay an executive benefits at a future date, usually retirement, and purchases life insurance on the executive's life to fund that obligation. The employer is the owner and beneficiary of the policy. If the executive dies before receiving the promised benefits, the death benefit helps the employer recover the cost of the arrangement. The arrangement creates a liability for the employer and a future income for the executive, and the life insurance provides a tax-efficient funding vehicle. This is a distinct use from key person coverage, which protects the employer against its own loss from a key employee's death.
Why the other options are wrong
- A key person policy protects the employer against its own economic loss from the death of a key employee; it is not tied to a promise of future retirement benefits to the executive.
- Business overhead expense coverage pays the ongoing expenses of a business during an owner's disability; it is a disability product, not a vehicle for funding retirement benefits.
- A split-dollar arrangement splits the premium payments and the benefits between the employer and the employee; it is a sharing device, not a promise to pay retirement benefits.
Memory hook
Deferred compensation means pay later; life insurance is the funding engine that makes the later payment possible.