How to Insure Your Income: Funding Options
Some techniques may be employed to help solve the problem of uncertain future delivery -- and thus provide some security for a key employee -- while assuring that the plan remains unfunded. This assurance is realized as long as the asset is accessible to the employer or the employer's creditors.
- Life insurance. Corporate-owned life insurance on the key executive's life results in funds that can be used to finance the employer's responsibility in accordance with the deferred compensation agreement. If the employee dies prematurely, adequate cash is available to pay the deferred compensation benefit. The policy's cash value also can be used to help provide retirement or disability benefits.
- Annuity contracts. Corporate-owned annuities can provide necessary retirement funding in accordance with the deferred compensation agreement.
- Disability income insurance. A corporate-owned disability income policy on the life of the key executive could provide the necessary funds with which to pay a disability benefit in accordance with the agreement.
- An employer investment account. The employer invests in stocks, bonds, mutual funds, etc., and maintains this investment account for the purpose of having funds to implement the deferred compensation plan. As long as the account is accessible to the employer and the employer's creditors, it will not be considered a funded plan.
Money must be generated or accumulated with which to pay the life insurance premiums. This is generally considered a legitimate business expense if it enhances the business. However, if it only satisfies the needs of a majority stockholder/owner, then this would not be a legitimate business expense for tax purposes. As money would be accumulated to pay the premiums for this invalid business expense, the corporation may be subjecting itself to an accumulated earnings tax liability.
