Page 302 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

288 The Complete Guide to Executive Compensation

specified dollar multiples (e.g., $50,000) or in multiples of pay (e.g., one, two, or three) to a
stated dollar maximum (e.g., $1,000,000). The advantage of the dollar-maximum approach is
that insurance protection is automatically increased with each compensation increase. This
can be an important factor since it is common for such plans to have an open enrollment
period at time adopted or within a short period of employment (e.g., 30 days); after that
period, enrollment or increases in dollar protection often require successfully passing a
medical examination. This medical exam requirement for increased insurance can be over-
come by using the multiple-of-pay approach, since the increase in protection is automatic.
Since the $50,000 tax-free insurance limitation can only be used once each year, it nor-
mally is applied to the bargain portion of the basic plan. Thus, for supplementary insurance
to escape imputed income, the cost to the employee must be equal to or in excess of the
Section 79 rates. Like other forms of insurance, this is probably of moderate importance to
executives.
Carve-Out Insurance. Another variation of the supplemental insurance is a carve-out plan,
where the company provides the first $50,000 of insurance at no cost and the employee pays
for the remainder provided by the plan formula (either a flat amount or percentage of pay).
In accordance with Section 79, there would be no tax consequences to the employee as long
as the rates charged were greater than those set by the IRS.

Combination Term and Permanent Life Insurance. Often called Section 79 plans, they
were designed to take advantage of the annual $50,000 benefit exclusion and Uniform
Premium Table rates provided under the 1964 addition of Section 79 to the Internal Revenue
Code (see Table 6-13). A popular approach was to place a Section 79 plan on top of an
existing group term plan and limit participation to the top executives.
A typical Section 79 plan would call for scheduled amounts of life insurance, one part
being decreasing term insurance and the other part being offsetting increases in permanent
protection. The employer would pay the premium on the term portion (deductible under
Section 162 of the IRC), creating imputed income to the executive in accord with the Uniform
Premium Table for coverage in excess of $50,000. The executive would pay the premium on
the permanent life portion; however, the company would assist in this matter by increasing
salary or bonus by a comparable (or grossed-up) amount. Furthermore, as cash value started
to build on the permanent insurance, offsetting the decreases in term coverage, the accumu-
lated cash value often exceeded the actual taxes paid for imputed income. The employer
received a tax deduction for group insurance premiums and compensation expense; the exec-
utive had income imputed at favorable rates on the term portion and compensation income on
the other portion. This structure neatly avoided the issue of the non-tax-deductibility of
permanent life insurance premiums, as well as reduced the amount of term coverage in later
years when the Uniform Premium Table rates reflected significant increases that would
otherwise result in large imputed income amounts.
The need to separate fairly the two insurance portions in order to receive the benefits of
Section 79 was reinforced with Revenue Ruling 71-360. In 1979, the requirements for such
plans to qualify under Section 79 were further tightened. Namely, these combination plans
had to specify in writing the amount of term coverage, allow the executive to decline (or sub-
sequently drop) the permanent insurance without any effect on the group term amount, and
provide a group term benefit not less than the total death benefit less the amount of paid-up
insurance.