LIFE INSURANCE FOR EXECUTIVES

Life insurance can be an important executive benefit. Life insurance is important to high income employees as a means of providing income security to their families during the early part of their careers. In later years, it can provide or augment the executive's estate to be left to family and other heirs, or it can help provide liquidity to the estate to meet estate taxes and other expenses. A number of methods with favorable tax consequences have been devised to provide life insurance to executives. Generally, the aim is to provide insurance in a way that minimizes the current year-to-year income tax cost of the plan to the employee, and also keeps the life insurance out of the employee's estate for federal estate tax purposes. Some of the methods used include the following:

• Split-Dollar Plans. In a split-dollar plan, cash-value life insurance is used, with the death benefit divided or split between the employer and the employee's designated beneficiary. The premium can be paid entirely by the employer or premium costs can be shared between employer and employee. The employer does not receive a tax deduction for its share of the premium payments. However, the plan is designed so that the employer is reimbursed for its premium payments by its share of the death benefit, which is received by the employer tax-free. Thus, the employer's cost for a split-dollar plan is the loss of the use of its share of the premium payments during the time in which the plan is in effect.

• Many variations on the basic split-dollar approach are possible. For example, to avoid federal estate taxes, the plan is often designed so that the employee has no incidents of ownership in the policy. This can be done, for example, by having the policy applied for by a beneficiary such as a spouse or a family trust, with a split-dollar arrangement between the employer company and the policyholder. Although this arrangement may eliminate the federal estate tax in the employee's estate, it is still considered by the IRS to result in compensation income to the employee.

• Death Benefit Only (DBO) Plans. A DBO plan is a form of deferred-compensation plan in which the benefits are paid only to a designated beneficiary upon the death of the employee. The purpose of this arrangement is to avoid federal estate taxes on the death benefit.

  Under the federal estate tax law, a death benefit from a deferred-compensation plan is included in the employee's estate if the employee had a nonforfeitable right to receive benefits while living, even if the employee never actually received such benefits while alive. Thus, the DBO benefit is designed to be paid only at death. If there is a DBO plan, the employer's fringe benefit arrangements for the employee must also be designed carefully to make sure the DBO plan will accomplish its intended purpose. The IRS will lump other deferred-compensation plans-not including qualified plans-together with the DBO plan to determine if the company provides a lifetime benefit to the employee.

  To provide a substantial death benefit even during the early years of the plan, DBO plans are usually funded informally with life insurance. That is, the employer owns insurance on the life of the employee, with the employer itself as beneficiary. At the death of the employee, the policy provides funds enabling the employer to pay the death benefit to the employee's beneficiary.

  For income tax purposes, a DBO plan is treated the same as any other deferred-compensation plan-death benefits are taxable in full to the beneficiary as ordinary income when received.

• Group Term Life Insurance Plan. Under Section 79, a group term life insurance plan can have a special class for executives and provide them with amounts of group term insurance relatively greater than the amounts provided for other employees. However, if the plan provides amounts of insurance that are higher multiples of compensation for key employees, it probably will be deemed discriminatory and, therefore, the tax exclusion for the value of the first $50,000 of insurance will be lost by key employees.