Page 299 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 6. Employee Benefits and Perquisites 285

basis (e.g., over 15 years). Although the beneficiary of the deferrals may be subject to
the same earn-out schedule, usually the present value of all future payments will become
part of the executive’s estate for tax purposes. It is difficult enough to liquidate assets to
pay taxes; needless to say, it is much harder to pay taxes when the assets are not available for
liquidation.
Given that tax law and IRS interpretations are continuing to evolve, no attempt is made
here to describe the tax consequences, since it would most assuredly be out-of-date by time
of publication. The same caution applies to SEC interpretations.
Depending on the number of executives covered, the amount of insurance, and the
premium split, the company may be expending millions of dollars annually. The use of
less expensive term insurance might accomplish similar objectives. One such approach is
discussed next.
Retired Lives Reserve. With the retired lives reserve (RLR) concept, the company prefunds
the executive’s postretirement life insurance by making tax-deductible contributions to a
reserve fund (which in turn pays for the cost of insurance protection after retirement) to
purchase a deferred life insurance policy or continue premium payments after retirement.
Normally, this approach would have a trustee own the policy and be the beneficiary of a
post-65 life insurance policy on the executive. If the executive died after retirement, the trust
would receive the proceeds and pay them to the beneficiary designated by the executive. If
the executive died before age 65, the beneficiary would receive the life insurance proceeds
directly from the carrier under the pre-65 policy. An executive who died before 65 would
have no rights under the post-65 plan, and the proceeds paid to the trust from the RLR
would be used to reduce the company’s premium obligations for other covered executives.
Proceeds paid directly to the company would be considered taxable income.
Revenue Ruling 69-382 allows deductions by the company of prefunded retirement life
insurance if (1) the reserve is solely for providing life insurance benefits to those covered,
(2) the amounts in reserve are not returned to the company as long as any covered employees
or retirees are alive, and (3) annual additions to the reserve are not greater than needed to meet
the insurance obligations. This type of deduction was further protected by Revenue Ruling
73-599, which ruled that retired lives reserve plans are not deferred compensation plans. If
they were, the company could not take deductions when paid but rather when received by the
beneficiary.
The executive has no tax liability under the RLR before age 65, although the person is,
of course, subject to imputed income for amounts of insurance in excess of $50,000.
Furthermore, it appears that as long as the RLR is deemed to be group life insurance after
retirement, the retired executive has no tax liability at that point either. Assuming the indi-
vidual has successfully assigned the policy, it may also be possible to avoid estate taxes,
although under Revenue Ruling 76-490, the executive is considered to have made a gift each
year of the value of the assigned group life insurance benefit.
Some argue that RLR is a more cost-effective approach than split-dollar insurance to
meet similar objectives. At least the company is obtaining a tax deduction on the RLR cost,
and it appears that the executive’s tax liability may be more favorable than under split-dollar
insurance.
However, the IRS may be concerned with the selectivity of megabuck RLR policies for
executives and whether such insurance is really permanent (not term) insurance. Both strike
at the application of Section 79 definitions. If RLR is not Section 79, then the protection