Chapter Ten

Uses of Life Insurance

Cross-Purchase Plan

a plan that, upon the business owners death, surviving owners will purchase the deceased’s interest in the business, often with the funds from life insurance policies owned by each principal on the lives of the all the other principals

Entity Plan

an agreement whereby a business assumes the obligation of purchasing a deceased owner’s interest in the business, which proportionately increases the interests of the surviving owners

Key Person Insurance

this insurance protects a business against financial loss caused by the death or disability of a vital member of the company, often individuals who possess special managerial or technical skills or other expertise

Human Life Value Approach

This is a method of determining an individual’s economic worth as measured by the sum of the individual’s future earnings that is devoted to the individual’s family - the projected income earned per year must be multiplied by the number of years until retirement - the projected income takes into account expenses that will be paid out of the earnings, such as income tax and cost of living - provide approximate amount of coverage needed - determines the value of an individual’s future earning potential based on current circumstances - this formula does not account for a family’s needs, goals, etc., only potential lost income.

Needs Approach

a method for determining how much insurance protection a person should have by analyzing a family’s or business’s needs and objectives if the insured were to die, become disabled, or retire - focuses on the insured’s final goals for those who would remain after his death like education or mortgage.

1. Use costs associated with death plus costs of financial objectives to determine a person’s (or family’s) capital needs.

2. the person’s liquid assets are calculated (savings, pension, life insurance, SSI, interest from bonds, dividends from mutual funds or stocks, rental income, and any other income to which the person is entitled

3. Subtract liquid assets from total capital needs to determine the amount of coverage needed

Interest-Only Method

this is a method for determining the appropriate amount of life insurance - determines how much insurance is needed to maintain after-tax family consumption levels if the insurer maintains the principal for future payments

Multiple-of-Earnings Method

this is a method for determining an appropriate amount of life insurance - provides a rough estimate of one’s insurance needs - uses 5 or 7 times one’s earnings as the basis for calculating need

“Seat of the Pants” Method

a method for determining the appropriate amount of life insurance - the amount of life insurance is arbitrarily selected

Deferred Compensation

A business use of life insurance where the employer promises to pay a key employee later, and they use life insurance as a way to help make those payments, or be reimbursed for the payments when the employee dies. The employer owns the policy, makes payments, and is the beneficiary.

Split-Dollar Plan

a business use for life insurance where an employer and key employee split the premiums, rights, death benefit, cash value, or all of these things. The employer or employee can own the policy with this use, it just depends on how they have it setup.

Executive Bonus Plan

a business use for life insurance where an employer gives a key employee a bonus in order to purchase life insurance. The employee owns the policy. The bonus is tax-deductible for the business, and the bonus is taxed as income for the employee. The employee can set their own beneficiary, and their rights to cash value are the same as if they had not purchased the policy with a bonus from their employer - also referred to as an section 162 plan

Salary Continuation Plan

a business use for life insurance where an employer promises to continue the employee’s salary after they retire, or to their family after they die for a specified period of time. The company will likely use a life insurance policy to help make these payments via the cash value, or be reimbursed for these payments via the death benefit. The employer owns they policy, pays the policy, and receives the death benefit of the policy.

Buy-Sell Plan (Sole Proprietor)

business use of Life Insurance - a two step plan to ensure business continuity after the death of a sole proprietor. There will be an agreement for a key employee to purchase the business at a pre-agreed price, then the employee buys a life insurance policy on the SP’s life to fund the purchase. The employee is the owner, payor, and beneficiary.

Entity Plan

business use of LI - a plan/agreement where the partnership buys out the deceased person’s portion of the company - the partnership purchases, owns, and pays for a LIP on each Partner, and then the Partnership uses the proceeds from the LIP to fund the purchase of the deceased partner’s portion of the business

Cross-Purchase Plan

business use of LI - a plan/agreement where all partners purchase, own, and are the beneficiary on LIPs on the other partners, each partner uses the proceeds from their LIP to purchase their share of the deceased partner’s share - every partner has a LIP on the life of each of the other partners

Buy-Sell Funding for Corporations

business use of LI - a plan for a corporation to purchase a deceased stockholder’s shares of the company - called a Stock Redemption Plan, the corporation buys LIPs on each major stockholder, and they use the proceeds to purchase the shares of the deceased stockholder.