D—Deferred Compensation and Business Life Insurance

In allowing selected management or highly compensated employees to defer income until after retirement, deferred compensation offers multiple tax advantages to both the employer and the participant.

Corporate Obligation. To illustrate, assume we have a key corporate manager who is currently age 45. Under its terms, the plan would provide for retirement payments, at age 65, of $10,000 per year for 10 years. These payments would be tax-deductible to the corporation when made, and, although taxable to the retired employee, presumably he would pay less in taxes due to a reduced retirement income and resulting lower marginal tax bracket.

Typically, such plans also provide for survivor payments if the employee dies prior to retirement. For example, should the employee die at age 55, a typical plan might pay his surviving family $10,000 per year for 10 years. Since these payments would be tax-deductible to the corporation, each $10,000 payment would cost only $7,900 (assuming a 21 percent corporate marginal tax bracket). However, these payments would be taxable income to the family. Life insurance cash values grow on an income tax deferred basis and death benefits are ordinarily received on an income tax free basis – making life insurance a common and tax-effective method of funding deferred compensation obligations.