Page 292 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)
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278 The Complete Guide to Executive Compensation
amount to meet other claims), oftentimes in mortgages. Another portion is credited to a
reserve for the policyholder, usually beginning several years after the policy has been
purchased. This cash value is available to the policyholder during the period of insurance
protection in the form of a loan against the value of the policy. The rate of interest is speci-
fied in the contract. For many, these rates are significantly below what the individual would
have to pay a bank. Furthermore, there is usually no prescribed payment date, and even
unpaid interest is simply added to the loan. However, when the insured dies, the cash value
is not an additional amount but is included in the face amount on the policy; furthermore,
the value of the outstanding loan will be subtracted from the face value of the policy at the
time of the insured’s death. Typically, the employee can expect to be taxed on the employer’s
contribution to permanent insurance unless the policy is forfeitable at time of termination.
Term. Insurance that specifies the term or period during which the value of the policy is in
force is called term insurance. For example, Twenty-year Term means the policy is only good
for the first 20 years; if the insured lives beyond that point in time, the policy has no value.
The cost of term insurance is very low, especially if purchased while young (e.g., in the twen-
ties or early thirties). However, the cost increases with age. By the time one has reached the
sixties, the cost has increased very dramatically. Term insurance is pure insurance protection,
paying only at time of death if the policy is still in force. There is no cash value, but it is the
most cost-effective policy if death occurs during the term.
A variation on the straight term insurance contract is the return-of-premium term contract.
At the end of a stated period of time (e.g., 30 years), all premiums (without interest) are
returned and the policy is canceled. If death occurs before this date, the face value of the
policy is paid to the designated beneficiary (without the return of any premiums).
Some policies are renewable. A renewable policy may continue for another prescribed
period of time (at a higher premium) without having to undergo a medical examination. In
addition, the term policy may be convertible, which means before its expiration, the insured
may switch over to another form of insurance (e.g., whole life or endowment). Contracts with
such provisions cost more than straight term since they guarantee coverage beyond the
normal term even if health is poor. In addition, the payer pays a one-time conversion charge
(e.g., $25 for every $100 of group term insurance converted).
Term is the typical form of insurance provided by companies to their employees. Called
group term, it identifies a group of eligible employees and provides insurance coverage typi-
cally until (1) the employee leaves or (2) the contract expires (traditionally the contract is
renewed annually), whichever occurs first.
It is advantageous to have the definition of “group” acceptable to the IRS, because in
accordance with Section 79 of the IRC, the first $50,000 of coverage incurs no income tax
liability. Typically, a group plan benefits at least 70 percent of the employer’s employees and
at least 85 percent of all participants, excluding key employees.
Table 6-12 shows a worksheet indicating how this calculation is made. Note that in this
example the executive is paying more than the minimum required by the IRS tax table
(see Table 6-13) and therefore there is no tax liability. Increase the age to 57 and the indi-
vidual has a $1,730 imputed income figure (i.e., $2,340 $610). Assuming a 50 percent
marginal tax bracket, this is a bargain since the executive would pay $865 tax rather than a
total premium of $2,340. Actually, it is a bargain only if the executive wants the insurance;
an executive who does not want it will only look at the additional $865 as an unnecessary
tax liability.