I—Reverse Key Person Insurance
Reverse key person insurance offers an alternative means of providing key employee insurance by having someone other than the business purchase insurance on the life of the key employee. It is particularly useful with C corporations, where the corporate alternative minimum tax can reduce the death benefit received by the corporation. With reverse key person insurance there is no exposure to the alternative minimum tax, because the death benefit is not paid to the corporation. If the key employee is also a stockholder, payment of the death benefit outside the corporation also avoids increasing the value of the deceased’s stock and thereby avoids any increase in estate taxes.
DURING LIFETIME.Such a program can be established by having the trustee of an irrevocable life insurance trust purchase insurance on the key employee. As both owner and beneficiary of the contract, the trustee pays the premiums directly to the insurance company.
Many guidelines are used in estimating the dollar value of a particular key employee. However, the value can be most easily estimated by using a factor of three to ten times the employee’s salary. Other guidelines that have been employed involve either a determination of the employee’s replacement cost, or an estimation of lost profits or credit.
UPON DEATHof the key employee the insurance company pays the death benefit directly to the trustee of the trust. The proceeds are received free of income taxes as the death benefit of a life insurance contract.
The funds can then be loaned by the trustee to the corporation. In repaying this loan the corporation makes tax-deductible interest payments to the trust. Although these interest payments are taxable income to the trust, repayments of the loan principal are received by the trust free of income taxes.
Of course, it is not necessary for a trust to be established. Anyone who has the funds can loan them to the corporation for the purpose of key person insurance. For example, an adult child could be the owner and beneficiary of a life insurance contract insuring his parent. After receipt of the death benefit, the proceeds could be loaned by the child to the corporation, which would then repay the loan together with interest.
Cross References - Concepts Illustrated
Restricted Executive Bonus
Plan (REBA)
Non-Qualified Deferred
Compensation
Deferred Compensation
Opportunities
Split Dollar—Economic Benefit
Regime— Employer Pay All
Split Dollar (Non-equity
Collateral Assignment) with Irrevocable Trust
Split Dollar Funding of Cross
Purchase Agreement