Chapter 10: Uses of Life Insurance
when working with a client, the insurance producer should consider the following individual needs: (needs approach)
* Final Expense Fund!!!! * Housing Fund!!!!!!!!! * Education Fund!!!!!!! * Monthly Income!!!!!! * Emergency Fund * Income Needs if Disabled or Ill * Retirement Income * Estate Conservation (using life insurance to enable heirs to pay estate taxes) * NEEDS include ANY(ONE or THING) depending on that person, charity, child, pet,
-Types of Buy-sell Agreements Used For Partnerships and Corporations
* cross purchase method * entity purchase method * stock purchase method * stock redemption method
human life value approach
* gives the insruaed an estimate of hwat would be lost to the family in the event of the premature death of the insured... It calcluated an indivudals lfie value by looking at the insured's wages, inflation, and the number of years to retirement * Calculates the amount of money a person is expected to earn over his lifetime to determine the face amount of life insurance needed, thereby placing a dollar value on the life of an individual.
Individual Uses of Life Insurance
* the death of the primary wage earner will usually stop the flow of income to a family. * the death of a non-earning spouse who cares for minor children can also cause great financial hardship for the family * planning fo survivor protection requires careful examination of current assets and liabilities as well as determining what the needs of the survivors may be.
BUSINESS USES OF LIFE INSURANCE
* the most common use of life insruance by businesses is an empoloyee benefit, which serves as a protectoin for employees and their beneficiaries * Buy-Sell agreements are also known as business continuation agreements and are used to assure the ownership of the business is properly transferred upon the death or disability of an owner or partner. Third-party ownership of life insurance policies is widely used in business insurance and estate- planning situations.
vatical settlements
Allows someone with a terminal illness to sell their existing life insurance policy to a third party for a percentage of the death benefit. The new owner continues to make the premium payments and will eventually collect the entire death benefit.
close cooperation cross-purchase plan
Similar to partnership cross-purchase plans, a close corporation cross-purchase plan requires surviving stockholders purchase the deceased stockholder's interest in the company, and the deceased stockholder's estate sell the interest to the surviving stockholders. The corporation is not part of the buy-sell plan. Each stockholder owns, pays the premiums and is the beneficiary of life insurance on each of the other stockholders in an amount equal to his share of the corporation's purchase price.
Buy-Sell Funding for Close Corporations
Unlike a partnership, a close corporation (i.e. an incorporated family business) is legally separate from its owners. It exists after one or more owners dies. A close corporation may purchase either buy-sell plans: cross-purchase or entity. The difference is that an entity plan is termed a stock redemption plan for close corporations.
determining life insurance needs
individuals seeking to buy life insurance may need assistance trying to establish how much coverage is appropriate, based on their ability to pay the premium
Deferred Compensation
is an executive benefit an employer can use to pay a highly paid employee at a later date, such as upon disability, retirement or death.
Salary Continuation Plan
works the same as deferred compensation except that the employer funds the plan rather than the employee. The employer establishes an agreement, whereby an employee will continue to receive income payments upon death, disability or retirement.
Salary Continuation Plan:
works the same as deferred compensation except that the employer funds the plan rather than the employee. The employer establishes an agreement, whereby an employee will continue to receive income payments upon death, disability or retirement.
buy-sell plan
* a legal contract that determines what will be done with a business in the event that an owner dies or becomes disabled. * an attorney drafts a buy-sell plan stating the employee's agreement to purchase the proprietor's estate and sell the business at a price that has been agreed-upon beforehand.
needs approach
* based on the prediected needs of a family after the premature death of the insured. * A method of life insurance planning which identifies the needs of an individual and the individual's dependents. This approach determines the total funds available to a family from all sources and subtracts the amount needed to meet their financial objectives. It takes into consideration: * The needs approach to personal life insurance planning may involve creating a lump sum to provide for such things as education, retirement, and charitable * The needs approach to personal life insurance planning also includes the creation of an emergency reserve fund. This fund is designed primarily to cover the cost of unexpected expenses. * The "needs approach" in life insurance is most useful in determining how much life insurance a client should apply for.
cross-purchase plans
In a cross-purchase plan, each partner buys, pays the premiums, and is the beneficiary of a life insurance policy on each of the other partners. The amount of the policy is equivalent to each partner's share of the business. When one partner dies, each of the other partners receives the death benefit from the life insurance on the deceased partner, which is then used to buy the deceased partner's ownership of the business.
Close Corporation Stock Redemption Plan
Similar to the partnership entity plan, the corporation purchases, is the owner, pays the premiums and is the beneficiary of life insurance policies on each stockholder. The amount of life insurance is equal to each stockholder's share of the corporation's purchase price. When a stockholder dies, the corporation purchases, or redeems, the deceased stockholder's share.
Two partners own equal shares in a business worth a total of $1,000,000. If they both commit to the purchase of a life insurance policy that will fund a Buy-Sell Agreement, which of the following is TRUE?
a) each partner owns a $1,000,000 policy on their own life. b) each partner owns a $1,00,000 policy on their partners life c) each partner owns a $500,000 policy on their own life d) each partner owns a $500,000 policy on their partners life Ans: D - the amount of the policy is equivalent to each partner's share of the business. when one partner dies, the other partner receives the death benefit from the life insurance on the decreased partner, which is then used to buy the decreased partner's ownership of the business.
insurance policy
the employee purchases a life insurance policy on the life of the proprietor. The employee is the policyowner, beneficiary, and pays the premiums. Upon the proprietor's death, the funds from the policy are used to buy the business.
entity plans
the partnership itself agrees to buy the deceased partner's share of the business. Entity plans are best for businesses with several partners. In this case, the business purchases, pays the premiums and is the beneficiary of life insurance on each partner.
key person insurance
* a business can lose buisness bc of the death of a key employee * The purpose of key person insurance is to prevent the financial loss that may ensue when an owner, officer or manager dies. * It pays for finding and training a replacement if the key employee dies prematurely. also pays for the reduction of profits, loss of new business and the loss of leadership all resulting from the key person's death. * The company purchases, owns, pays the premiums and is the beneficiary of the life insurance policy on the key person. * The premiums are not deductible for income purposes. However, the death proceeds received by the business are not taxable.
Buy-Sell Funding for Partnerships
There are two types of buy-sell agreements for partnerships: cross-purchase plans and entity plans.
Buy-Sell Funding for Sole Proprietors
There is a two-step business continuation plan to keep the business running after the proprietor's death, whereby the employee takes over management of the business: buy-sell plan and insurance policy
which type of plan allows an employer to give money to an employee for buying a life insurance policy and also permits the employee to select the beneficiary?
a) split- dollar plan b) employer purchase plan c) key employee plan d) deferred compensation plan Ans: A - A split-dollar plan is an arrangement where an employer and an employee share in the cost of purchasing a life insurance policy on the employee. the employee is also allowed to name the policy beneficiary.
the premiums paid by an employer for his employee's group life insurance are usually considered to be:
a) tax- deductible to the employer b) partially deductible to the employee c) tax-deductible to the employee d) taxable income to the employee Ans: A - the amount an employer pays for his employee's life insurance is typically deductible to the business
A Key Employee policy is taken out by Company X on its vice president. Ten years later, this employee leaves Company X and begins working for Company Y. If this individual were to die and the policy is still in force and unchanged, where would the death proceeds be directed?
a) the employee's family b) company Y c) company X d) The employee's estate ans: C - with key person insurance, the company purchases, owns, pays the premiums and is the beneficiary of the life insurance policy on the key person.
what is considered a valid reason for a small business to insure the lives of its major shareholders?
a) to provide an income for the surviving dependents b) reduce the company's tax liability c) to pay for final expenses d) fund a buy-sell agreement Ans: D - life insurance is purchased to fund a buy-sell agreement in the event of the death of a major shareholder in a business.
business uses of policy loans
can be used for needs such as to fund buy-sell agreements, deferred compensation for key people, and/or split-dollar agreements
Split-Dollar Plan
is an arrangement where an employer and an employee share in the cost of purchasing a life insurance policy on the employee. It is a method of buying insurance, not an insurance policy itself. Many times it is a combination of term and whole life insurance.
split-dollar plan
is an arrangement where an employer and an employee share in the cost of purchasing a life insurance policy on the employee. It is a method of buying insurance, not an insurance policy itself. Many times it is a combination of term and whole life insurance.
deferred compensation plan
is an executive benefit an employer can use to pay a highly paid employee at a later date, such as upon disability, retirement or death.
