Quiz: Business Uses of Life Insurance

Which statement is true under a split-dollar life insurance plan? A. The employee pays all of the premiums. B. The employee gets temporary insurance protection. C. The employer and employee split the premiums. D. The employee receives the entire death benefit.

C. The employer and employee split the premiums. Under a split-dollar life insurance plan, a permanent life insurance policy is bought on the life of a key executive. The premiums are split between the employer and the executive.

If four business partners enter into a cross-purchase buy-sell agreement, what is the total number of life insurance policies that will be needed to fully insure this agreement? A. 6 B. 12 C. 4 D. 16

B. 12 The formula to determine the number of policies is N × (N-1), where N is the number of partners. In this case, four partners will have to buy a total of 12 policies (i.e., 4 × 3).

All the following statements regarding an insured executive bonus plan are correct EXCEPT: A. The employer is required to pay all of the premiums for the policy. B. The employer can take an income tax deduction for premium payments it makes under the policy. C. The executive can choose the beneficiary under the policy. D. The executive owns the life insurance policy.

A. The employer is required to pay all of the premiums for the policy. Because they own the policy, executives can choose the beneficiary.

What is the main purpose of key person insurance? A. to compensate the business for the loss of its key employee B. to provide retirement benefits to key employees C. to add to an employee's salary at retirement D. to compensate the key employee's family when he or she dies

A. to compensate the business for the loss of its key employee Key person insurance coverage compensates the business for the loss it suffers when a key employee dies. The death benefit proceeds provide the business with an important financial cushion when the key employee dies.

What is the main difference between a traditional deferred compensation plan and a salary continuation plan? A. Term life insurance is often used to fund a deferred compensation plan. B. The employee funds the future benefit under a salary continuation plan. C. The covered employee does not defer compensation with a salary continuation plan. D. The employer cannot deduct benefits that are paid under a salary continuation plan.

C. The covered employee does not defer compensation with a salary continuation plan. With a salary continuation plan, the employer funds, or pays for, the future benefit. In contrast, in a traditional deferred compensation plan, the employee funds the benefit by deferring a portion of current compensation.

Which one of the following is the most appropriate use of life insurance? A. buying life insurance to obtain workers' compensation protection B. buying life insurance to insure all the parties to a business buy-sell agreement C. buying life insurance on an unrelated person as an investment D. buying life insurance to save for a big vacation in several years

B. buying life insurance to insure all the parties to a business buy-sell agreement Life insurance is commonly used to provide stability and continuity in business situations.

Which of the following statements about insured executive bonus plans is correct? A. The employer must pay all of the premiums for the life insurance policy. B. The employer owns the life insurance policy. C. The portion of the premium paid by the employer can be deducted by the employer and is treated as taxable income to the executive. D. The employer is the beneficiary under the policy.

C. The portion of the premium paid by the employer can be deducted by the employer and is treated as taxable income to the executive. Because the executive owns the life insurance policy, he or she enjoys all of the rights of ownership, including the right to name the beneficiary.

Four shareholders of ABC Corporation, who each own a $1,000,000 interest in the company, enter into a stock redemption agreement funded with life insurance. If one shareholder dies six months later, all the following statements are correct EXCEPT: A. Each of the surviving shareholders will then own a one-third share of ABC Corporation. B. This is a form of entity-purchase buy-sell plan. C. The three remaining shareholders will buy the deceased owner's interest from his estate. D. The insurer will pay the $1,000,000 death benefit from the deceased owner's policy to ABC Corporation.

C. The three remaining shareholders will buy the deceased owner's interest from his estate. If a shareholder dies, ABC Corporation will buy the deceased owner's shares. The structure of the company will then change so that each surviving shareholder would own a one-third share of the company.