A closely held corporation wants to provide supplemental retirement income to a key executive. Under the plan, the corporation pays premiums on a permanent life policy and will receive the policy's cash value back at the executive's retirement. This business arrangement is best described as:

Why A is correct

Deferred compensation is a business arrangement in which the employer promises to pay an employee compensation at a later date, typically after retirement. The employer often funds the obligation with a permanent life insurance policy on the executive: the employer owns the policy, pays the premiums, receives the cash value back at retirement to fund the promised payments, and collects the death benefit if the executive dies before retirement, offsetting the obligation. This is distinct from key person insurance (protects the business against the economic loss of a key person's death), split dollar (shares premium and benefits between employer and employee), and wage continuation (replaces income during disability).

Why the other options are wrong

• B) Key person insurance pays the business a death benefit when a key employee dies, compensating the firm for the economic loss of that employee. Deferred compensation instead focuses on providing post-retirement income, not on indemnifying the business against a death.
• C) Split dollar splits premiums and benefits between the employer and employee on a single permanent policy. Here the employer funds the plan entirely and recovers its outlay from the policy while funding a retirement promise to the executive.
• D) A wage continuation plan replaces an employee’s income if the employee becomes disabled and cannot work. Deferred compensation is retirement-focused funding of a future payment obligation, so the two serve different purposes.

Memory hook

Deferred comp = pay the star later. Life policy funds the retirement promise; cash value bankrolls it.