Risk Management Flashcards
Buy-Sell : Cross Purchase
business owners buying insurance on each other for death, disability
of policies = N x (N-1) ; N is number of owners
Each owner pays premium to the insurance company for the death benefit for the other owners.
Death benefits are provided to the surviving owners.
Decednet’s company stock goes to his/her family or Estate.
Surviving owners will use the death benefits to buy the stock from family or estate.
Buy-Sell: Cross Pros and Cons
Advantages:
- Increase in basis for the surviving owner
- works best if you have fewer owners
- death benefits pass tax-free to surviving owners
Disadvantages:
- younger owners will pay considerably more in premiums if there are big age differences
- hard to implement with growing number of owners
Buy-Sell: Entity Purchase Agrt - Advantages
Preferred solution for businesses with multiple partners.
Death benefit passes tax-free to business.
Business pays policy premiums.
Buy-Sell: Entity Purchase Agrt - Disadvantages
No increase in cost basis to surviving owner(s).
Surviving owner(s) will have substantially more gains upon sale of business (due to lack of step-up).
What is a stock redemption buy-sell plan
Buy-Sell: Entity Purchase Agreements
If the business entity is a corporation, the plan may be referred to as stock redemption buy-sell plan
Buy-Sell: Entity Purchase Agreements
a method to completely transfer business interests back to the business (i.e., the entity) using life insurance policies.
The business purchases policies (pays premiums) on the owners and uses death benefit proceeds to buy back ownership shares from the decedent’s family or estate upon death of a partner.
Owners agree to establish a binding agreement with the business to buy and sell their respective business interests upon either:
Death,
Disability, or
Retirement
Buy-Sell: Entity Purchase Agreements - # of Policies Needed
The number of policies needed is equal to the number of partners and/or shareholders.
When setting up a buy-sell agreement with a larger number of partners, entity purchase plan is the more efficient method.
What’s more efficient method when setting up buy-sell agreements with large # of owners?
Entity purchase plan
Buy-Sell: Wait & See Agreements - 3 step process (BOB)
Following the death of a business partner, the following sequence of steps is set in motion:
Step 1: Business has 1st option to purchase the deceased partner’s stock.
Step 2: Surviving partner(s) have the option to purchase the deceased partner’s stock.
Applies if the business waives the option to purchase in Step 1, or The business purchases less than half of the deceased partner’s stock.
Step 3: Business is required to purchase the deceased partner’s stock.
Buy-Sell: Wait & See - who pays the premium
Owners take on life insurance policies on each other.
the agreement is to wait and see what to do about purchase of the decedent’s stock - Whether the business should buy it or owners should buy it
What are Living Distributions from Life Insurance Policy
Withdrawals and Loans
How are Living Distributions from MEC Policy treated?
LIFO
(Gains first)
How are Living Distributions from non-MEC policy treated?
FIFO
(Basis First = Premium’s First)
Taxation of death benefits for life insurance policies
Tax-free
7-Pay Test
Applies for Case Value Life Insurance Policies
policies that take in too much premium during the first 7 policy years, or in 7 years after a material change.
For each policy, a net level premium is calculated. If the total premium actually paid into the policy at any time during the 7-year testing period exceeds the sum of the net level premiums needed to result in a paid-up policy after 7 years, then the policy is a MEC.
Onec a MEC Always a MEC
Annuity Contract
It’s a investment contract for right to receive stream of income in the future
Purchaser can make one or multiple payments to insurance company and in exchange insurance company “guarantees” to pay stream of income in the future
Annuity Payments timeline
Annuity Payments can begin immediately or at a future date and can last for the predetermined time.
Accumulation Annuity
AKA deferred annuity
Accumulates funds and grows wealth over time, through tax deferred growth
Has two phases - accumulation phase and income phase (optional)
Grow tax deferred, can take withdrawals (charges may apply)
Income Annuity
Provide the guarantee of a steady stream of income in retirement
Priority is guaranteed income payments, not wealth accumulation
Fixed Annuity
guaranteed interest;
minimum and current
Equity Indexed Annuity
linked to an index; often S&P 500
point to point
participation rate
spread
caps
Variable Annuity
provides a variety of separate subaccounts which allow assets to be invested in securities such as stocks, bonds, money market accounts, etc.
The account owner can transfer assets between subaccounts.
Usually contain a fixed account which provides a guaranteed interest rate account.
Which annutization would have highest payout ?
- Single Life (ends at death of the annuitant)
- Joint Life
- Joint & Survivor (full, 2/3, 1/3)
Annuity Guaranteed Minimums
ONLY Applicable to Life Annuity Form of Payment
Refund certain - When annuitant dies before the period, lump sum or installment of guaranteed minimums to beneficiary
Period Certain - For a specified period of time
