The scene might look familiar. We’re in the conference room where Aaron, the business owner, presided over a meeting of his chief financial officer, his new life insurance agent and several of his professional advisors. Aaron has already considered the possible upcoming sunset of the current high estate and gift tax exemptions. (See “Will Your Life Insurance Sunset if the Tax Laws Don’t.”) This time, however, the conversation's not about planning for Aaron. It’s about planning for his executive team.
At the weekly gathering of Aaron’s executive team, one of the five members of the team brings up something unusual, life insurance and, more particularly, the lack of it in their package of benefits at the company.
Not a Total Surprise
It’s actually no surprise to Aaron that one of his team, a spouse and parent, would raise this topic. Just a few months ago, one of their colleagues passed away, leaving a spouse and children with far too little life insurance. After a couple of difficult conversations with the spouse, Aaron and the CFO put together a makeshift package of financial assistance for the family. The experience left Aaron a bit shaken. In fact, ever since then, the topic of life insurance for the team has been on his mind. But, you know, things got busy.
Aaron looks at his team and says, “I hear you. The CFO and I will take a look at this and let you know what we can do.” He then turns to the CFO and says, “Call our new agent. Tell her what’s on our minds and ask her to stop by.”
The Right Place to Start
When they speak, the CFO gives the agent some high-level background on the individuals who’d participate in the plan. Then the agent asks the CFO:
- “Do you want the death benefit paid to the executive’s beneficiary to be tax-free life insurance and not ordinary income?” “Absolutely,” says the CFO, “If we’re responding to a request for a life insurance plan, it should be a real life insurance plan.” That tells the agent to ignore death benefit only plans, which don’t provide a tax-free life insurance benefit to the beneficiary.
- “Do you want to provide permanent, meaning lifelong post-retirement coverage?” “Yes, absolutely,” says the CFO. This objective is easier, cheaper and less risky to accomplish with some plans than others, though explaining and illustrating why that’s true can be a challenge.
- “Can you send me a summary of the executives’ benefit package?” Beyond letting her know what they’re talking about when a given benefit plan is mentioned, the summary speaks volumes about the company’s approach to compensation, its tolerance for complexity and how the financial and tax aspects of a life insurance plan would round out the executives’ package.
- “Who will be joining you and Aaron at the meeting?” The CFO tells her that various advisors from the company’s law and accounting firms will be there.
The agent starts to draft an agenda for the meeting that she’ll send to the CFO for review. Right now, the draft’s more of a work plan for the presentation than an agenda. She knows from experience that the real challenge in these cases is to keep things as simple as possible, avoid insurance jargon and, most of all, illuminate the company’s path to an informed decision. Here’s what she has so far:
The Plan Options
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- Executive bonus plan (EBP) - Executive owns the policy and designates the beneficiary. The company pays a deductible premium and includes it in the executive’s income.
- Restricted executive bonus plan (REBA) - Same as EBP except the executive’s prohibited from accessing policy values for a certain period of time. The company’s tax advisor and my advanced sales team should confer about how the design of this plan could impact its tax implications.
- Split-dollar plans
- Endorsement plan (ESD) - Company owns the policy and pays a non-deducible premium and allows the executive to designate a beneficiary of a portion of the death benefit. Company includes the annual economic benefit in the executive’s income for as long as the plan is in force. Company recovers its outlay when executive dies.
- Collateral assignment plan under the loan regime (CASD) - Executive owns the policy; company lends the premiums and charges interest on the loans. The company recovers its outlay at earlier of executive’s retirement or death.
The Presentation Materials
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- A binder that has a tab for a section on each type of plan. Each section will include a diagram of the plan and bullet points on its structural, legal, financial, tax and administrative aspects.
- A sample agreement provided by the advanced sales group.
- Illustrations depicting both the company and the executives’ sides of each plan under just enough design variations to enable the company to see how the considerations that follow would impact items such as cost and complexity.
- A sample, single-page explanation sheet to be provided to the executives participating in the plan.
Key Decision Points
Though not suggested by the agenda, she’ll weave some of these points into the overview of the plans (and plant seeds for further consideration) when it makes sense to do so or if the conversation just drifts that way.
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- What does the company hope to accomplish by offering the plan? A company’s answer to this question often suggests that one type of plan is more suitable than another. For example, the elegant simplicity of a relatively unconstrained EBP might make it less suitable than other plans for a company looking to use the plan for long-term executive retention, cost recovery and so forth.
- How much life insurance should the plan provide to the executive for them to consider the plan worthwhile?
- Should the death benefit remain level or increase by some formula? Address cost and complexity.
- What percentage of the death benefit should the policy support after retirement and to what age?
- Under what assumptions will the company fund the policy to support the post-retirement coverage? Address this upfront so that it doesn’t become an issue later on.
- Control - Who should own the policy, the company or the executive?
- If the company chooses an ESD, when and on what terms will it transfer the policy to the executive? Be sure they see the lifelong economic benefit if the policy isn’t transferred and the tax and cash flow implications to the parties if it is.
- If the company will lend the premiums under a CASD plan, what are the variations on the theme of an exit strategy and the tax economics of each variation?
- Tax - Revisit and get a sense of priorities about major tax implications, for example, deductibility of premiums.
- What’s the company’s tolerance for administration, maintenance and tax compliance?
- Risks and responsibilities of the respective parties - Forewarned is forearmed.
- Life insurance policy selection and design - A separate discussion once the plan is selected.
She sends a more refined draft of the agenda to the CFO, asking him to share it with Aaron. They offer a suggestion here and a tweak there, but then sign off on it.
Pre-Presentation Comments
Before the presentation begins, Aaron turns to the CFO and says, “Since you’re one of the people we'll cover in the plan, you’re going to be my straw man. For each plan we discuss, let me know if you understand it, if you like it and if it meets your needs. If not, tell me why.”
He then turns to the advisors. “We all know that the company’s tried some plans that had great promise but turned out to be so complicated, so burdensome for our staff and so hard for the team to understand and appreciate, that they collapsed from their own weight. So, I want to accomplish our objective in the most simple, straightforward manner possible for both us and the team.
He turns to the agent, though he’s clearly addressing the whole group, “A few weeks ago, the CFO and I sat through a presentation on split-dollar. We heard the words ‘assuming’ and ‘depending’ more often than my grandkids say, ‘like’ and ‘I mean.’ I don’t want a plan that involves any more assumptions or contingencies than absolutely necessary. I don’t want a plan or even an insurance policy that requires my people to have your background or the background of one of my advisors to understand it. I don’t want a plan that the CFO and I have to resell to the team every time we get together. Finally, I want to be sure that our obligations under the plan are clear so that when we’ve done what we’re supposed to do, we’re done, period. I don’t want anyone to be able to come back at us saying that we didn’t keep up our end of the deal.”
The Presentation
The agent smiles to herself, thinking that although he doesn’t realize it, Aaron’s already selected the type of plan he’d be comfortable presenting to his team. He’s also precluded certain types of products from consideration. But she’s been surprised before, so the show must go on.
The agent walks the group through the binder, plan by plan, taking plenty of questions as she goes along. Then she says, “Please look at the last page of the binder. You’ll see a matrix, which I’m going to replicate on the white board. You’ll see there’s a column for each of the four types of plans. Along the left, you’ll see one row for each of the primary decision points. Starting with the first column, let’s go row by row, assigning a ranking value from one to four, with one being least favorable and four being most.”
The meeting adjourns, with agreement to regroup in a week to conclude deliberations, help Aaron and the CFO arrive at a decision and even address some of the high level design points of the selected plan. After that, the agent will walk the CFO through all the steps of the implementation process and the expected timeline. Of course, she already has a one-pager for that as well.
Use of Policy in Retirement
Before leaving, the agent suggests to Aaron and the CFO that when they’re ready to roll out the plan, they include some time for a seminar on financial and estate planning for the team. One topic to include in the seminar should be the various ways they can use the policy in retirement.
“Great idea, especially after what we went through last time.” says Aaron
