A business wishes to fund a deferred compensation arrangement for a key executive. How is life insurance commonly used?
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Answer & full 3-part explanation (select an option above, or peek)
Why C is correct
In a deferred compensation plan, the employer promises to pay the executive compensation in future years, typically after retirement. To fund that promise, the employer often buys and owns a life insurance policy on the executive's life. While the executive is alive, the cash value grows tax-deferred and helps fund the future obligation; if the executive dies first, the death benefit provides the money to satisfy the promised payments to the executive's estate or beneficiaries. The employer is the policyowner and pays the premiums, and the arrangement must be carefully documented to meet tax and ERISA requirements.
Why the other options are wrong
- A) Coverage runs in the wrong direction; the employer, not the executive, owns the policy on the executive's life in a typical deferred compensation arrangement.
- B) The insurer does not pay salaries; it pays policy proceeds. The employer remains responsible for the promised compensation and uses policy cash value or death benefit to fund it.
- D) There is no requirement that the policy be purchased through any particular agent; the validity of the arrangement does not depend on the sales channel used.
Memory hook
Employer insures the key person and banks the cash value to fund tomorrow's deferred pay.