Social Security, Retirement Plans & Life Insurance Uses 

 January 26, 2022


Social Security, Retirement Plans & Life Insurance Uses

  1. Basic Principles of Life, Health Insurance and Annuities
  2. Nature of Insurance; Risk, Perils and Hazards
  3. Legal Concepts of the Insurance Contract
  4. Life Insurance Policies, Provisions, Options and Riders
  5. Life Insurance Premiums, Proceeds and Beneficiaries
  6. Life Insurance Underwriting and Policy Issue
  7. Group Life Insurance
  8. Annuities
  9. Social Security
  10. Retirement Plans
  11. Uses of Life Insurance
  12. Health and Accident Insurance
  13. Health Insurance Providers
  14. Disability Income Insurance
  15. Medical Expense Insurance
  16. Private Insurance Plans for Seniors
  17. Health Insurance Policy Provisions
  18. Health Insurance Underwriting
  19. Michigan Laws and Rules Pertinent to Insurance

Table of Contents

Master The Following:

  • Characteristics of Social Security
  • Types of OASDHI Benefits
  • Qualified Vs Nonqualified Plans
  • Qualified Employer Plans Characteristics
  • Qualified Defined Contribution Plans
  • Qualified Defined Benefit Plans
  • Qualified Salary Reduction Plans
  • Qualified Plans for Small Employers
  • Qualified Individual Retirement Plans
  • Pension Protection Act
  • Education Savings Plans
  • Nonqualified Retirement Plans
  • Determining the Proper Amount of Life Insurance
  • Individual Uses for life Insurance
  • Business Uses of Life Insurance
  • Employee Benefit Plan

focused on:

  • How Social Security Benefits Are Calculated.
  • Who Is Eligible and Covered under Social Security.
  • Differentiate between Fully Insured & Currently Insured.
  • How social security Benefits are Funded.
  • Taxation of social security
  • Types of OASDHI benefits
  • Concept of Dual Benefit liability
  • Concept of Disability
  • Difference between Qualified Vs Nonqualified Plans
  • Types of Qualified Plans
  • Traditional IRA Vs Roth IRA
  • Early Withdrawal Penalties
  • Section 529 Plans
  • Pension Protection Act of 2006
  • Determine between Human Life Value approach Vs Needs Approach
  • Difference between Individual Needs & Business Needs for Life Insurance
  • Corporate-owned annuities
  • Employee Benefit Plans


Characteristics Of Social Security

Social Insurance is provided by Social Security, also referred to as OASDHI. This is the Old Age Survivors Disability Health Insurance program. The social security program was signed into law in 1935 by President Roosevelt as part of the Social Security Act. Social Security is "funded" by payroll taxes collected from employee, employers, and those who are self-employed. Social Security provides several benefits to those who are eligible, including but not limited to retirement income, disability income, a lump sum death benefit, and survivor benefits.

It is a common misconception of many Americans that Social Security will fulfill all their financial needs. The Social Security system delivers a basic protection level to most working Americans against the financial problems brought on by death, disability, and ageing. Social Security arguments but does not replace a sound personal insurance plan.

The misunderstanding has resulted in Americans Discovering, often too late, they were inadequately covered when they needed life insurance, disability income, or retirement income.


The Old Age and Survivors Disability Heald Insurance (OASDHI) systems is commonly referred to as Social Security. Established during the Great Depression to assist the masses of people who could not afford to sustain their way of life because of unemployment, disability, illness, old age, or death.

Calculating Social Security Benefits

A person must be insured under the Social Security Program in order for a survivor, or retirement benefits to pay. Social Security benefits are based on how long a covered worker has worked though out his life.

The amount of Social Security benefits a person receives is based on the individual's Average Indexed Monthly Earnings (AIME) during their working years. Average indexed monthly earnings are used to account for inflation and bring past earnings up to current economic standards.

The Primary Insurance Amount (PIA) determines the full amount of retirement benefits for an eligible person at age 65. If a worker retires early, for example, at age 62, his retirement benefit will be 80% of his PIA and will remain lower for the covered worker's life.

Coverage & Eligibility

Social Security offers coverage to virtually every American who is employed or self-employed, with a few exceptions. Those not offered coverage include:

  • Most Federal employees before 1984 who are covered by Civil Service Retirement or another similar plan.
  • Approximately 25% of state and local government employees who are covered by a state pension program and elect not to participate in the Social Security Program.
  • Railroad workers covered under a separate federal program called the Railroad Retirement System.

Those who are actively contributing to the Social Security program through FICA taxes are considered covered. Coverage is NOT guarantee benefit eligibility. Each Social Security benefit has eligibility requirements that must be met prior to receiving the benefit.


Social Security establishes eligibility based on an "insured" status. There are two types of insured statuses that qualify individuals for Social Security benefits: fully insured and currently insured. Most Social Security benefits are paid to fully insured individuals.


A worker is considered to be fully insured if they have earned the required number of quarters of coverage. A worker with 40 quarters of coverage (i.e., ten years of employment) is considered to be fully insured. A fully insured worker is entitled to retirement benefits, and survivors are eligible for retirement benefits when the worker dies.

Fully insured status alone does not provide for disability benefits. This benefit is provided if a worker is fully insured and meets the definition of disability. In this case, a worker must have 40 quarters of coverage and 20 of the 40 quarters must be earned immediately preceding the disabling event. Therefore, under this classification, the worker is entitled to retirement benefits, disability benefits, and survivors are eligible for retirement benefits when the worker dies.

A worker is currently insured if he or she has earned at least six quarters of coverage in the 13 quarters immediately proceeding death of disability. This status provides for survivor benefits only. It does not provide for disability or retirement benefits.

To obtain a fully insured status, a covered worker must accrue a total of 40 quarters of credit, which is about ten years of work. To be considered currently insured and eligible for limited survivor benefits, a worker must have earned six credits during the last 13-quarter period.

To receive maximum benefits, the eligible individual must be "fully insured". This means that the person must have forty quarters of coverage. In other words, a person must have worked for ten years to be fully insured.

FUNDING Social Security Benefits

Funding for Social Security and all its social insurance counterparts (i.e., Medicare, Medicaid) is accomplished through the Federal Insurance Contributions Act (FICA) payroll taxes. Social Security payroll taxes are collected from employers (7.65%), employees (7.65%), and self-employed (15.3%). Therefore, employers, employees, and self-employed (i.e., Sole proprietor) fund social insurance programs.

FICA tax is applied to an employee's income up to a certain income amount. This amount is called the taxable wage base. There is a maximum amount of earnings that can be subject to Social Security tax each year. This amount is indexed each year to the national average wage index. This maximum applies to employers, employees, and self-employed individuals. Medicare Part A taxes are not subject to a maximum taxable wage cap. 

TAXATION Of Social Security Benefits

Social Security Benefits are subject to federal income tax if the beneficiary flies an individual tax return, and this annual income is greater than $25,000. Joint filers will pay federal income tax on their Social Security benefits if their income is greater than $32,000.

Types Of OASDHI Benefits

Death/Survivor's Benefits

Social Security Survivors benefits or death benefits pay a lump-sum death benefit and, in some cases, monthly income to survivors of deceased covered workers.

The program provides for a lump sum death benefit to be paid to the eligible spouse and, in some cases, the children when a fully or currently insured worker dies. The lump sum death benefit is $255 and has been capped at that amount for over 60 years.

In addition to the lump sum death benefit, Social Security provides a survivor monthly income equal to the deceased spouse's PIA at death. A surviving spouse of a fully insured deceased worker without dependent children is eligible for Social Security survivors benefits as early as age 60.

However, benefits are reduced if taken prior to age 65.

Survivor Benefits are also available to:

  • A spouse of any age who is caring for children under age 16, or over age 15 and disabled.
  • Unmarried children under age 18, or 19 if still in high school.
  • Children at any age if disabled before age 22 and remain disabled.

A Social Security Benefit of 75% of the Primary Insurance Amount (PIA) is given to an underage child of a deceased worker

  • Parents, beginning at age 62, of a deceased, fully insured worker, if the child provided at least 50% of the parent's support at the time of death.

A Social Security Benefit of 75% of the Primary Insurance Amount (PIA) is given to each eligible parent. If only one parent is eligible, the benefit is increased to 82.5% of the worker's PIA.

Blackout Period

The blackout period is the period of time from the insured's death until the surviving spouse is permitted to receive retirement income benefits. However, benefits are provided for the dependents (i.e., children) during the blackout period until the youngest child reaches age eighteen (18).

The "blackout period" begins when Social Security survivorship benefits cease. This is when the youngest child turns 16 years old, or immediately if no children. The "blackout period" ends when the surviving spouse turns at least 60 years old.

Benefits are paid to the children of a deceased worker during the blackout period until the youngest child reaches age eighteen (18).

Maximum Family Benefit

There is a limitation when several family members are eligible for Social Security benefits. Similar to the Primary Insurance Amount, a maximum family benefit is established by Social Security for every level of average earnings.

Retirement Benefits

Retirement benefits pay covered retired workers, their spouses, and other eligible dependents a monthly retirement income. Workers who are age 65 or older and fully insured are entitled to monthly retirement income for the remainder of their lives. The retirement income paid to a person who retires at age 65 is based upon the Primary Insurance Amount (PIA). The Retirement Income paid by Social Security begins on the first day of the month in which an eligible individual reaches age 65 (or other qualifying age). However, retirement income is not paid automatically when a retiree reaches age 65. 

The recipient must complete an application and submit it if he or she wishes to receive a monthly income. All other OASDHI / Social Security Benefits are based on this amount. Recipients may receive retirement income at age 62 if desired but at a reduced amount.

Full Retirement Age (FRA)

If a covered worker retires at the full (normal) retirement age, they will receive a 100% of the PIA, starting on the first day of the month in which they reach full retirement age. However, if a covered worker retires early at the age of 62, the maximum Social Security benefit is 80% of the PIA. This reduction remains all through retirement. Likewise, if a covered worker chooses to delay benefits beyond reaching full retirement age (up to age 70), they will experience a slight benefit increase.

Full retirement age (FRA), is also called normal retirement age (NRA), is the age at which retirement benefits are equal to the covered worker's PIA. While age 65 is typically thought of as full (normal) retirement age, full retirement age is determined by the covered worker's birth year. Age 65 is the full retirement age for covered retired workers born prior to 1938. Since 1938, the full retirement age gradually increase by a few months for every birth year until it reaches 67 for people born in 1960 and later.


When a person arrives at retirement age (age 65+), there is no limitation or restriction on the amount of income he or she can earn from any type of employment. If an individual decides to begin receiving retirement income prior to reaching full retirement age (age 62 through 64+), whatever they earn will reduce the retirement benefit to which he or she is entitled. This is know as the earning test.

Those who are under full retirement age for the entire year experience a benefit reduction of $1 for every $2 earned above the annual limit. For 2020, as an example, that limit is $19,240.

Those who reach full retirement age during the year experience a benefit reduction of $1 for every $3 earned above a different limit. For 2020, as an example, that limit is $48,600. Only earnings up to the month before you reach full retirement age count, not earnings for the entire year.

An individual collecting retirement income benefits at full retirement age is still allowed to work, and there is no longer any reduction of offset from Social Security Income.


An individual is sometimes eligible for two retirement income benefits. However, he or she is only allowed to collect one. For instance, a surviving spouse reaches age 65 or his or her actual retirement eligible age. He or she is now eligible for a retirement income benefit. However, he or she is also entitled to his or her deceased spouse's benefit, as well. Since both cannot be collected, the surviving spouse will select the greater of the two.

Disability Benefits

Disability benefits may be paid by Social Security (OASDHI) under the federal government or through state governments providing state-sponsored disability benefits or Worker's Compensation.

Social Security Disability Benefits are only available to covered workers who are fully insured, as defined by Social Security, at the time of disability. Disability, as defined for Social Security purposes, describes an employee who is unable to engage in any occupation. A person may first become eligible for disability benefits under Social Security after having been disabled for fire months. An individual is eligible for disability benefits under Social Security based upon his or her length of employment. These benefits will be paid to a worker (and eligible dependents) if that worker meets the restrictive total disability definition under Social Security.

  • Social Security disability benefits are only available prior to the age 65.
  • Social Security does not pay partial disability or short-term disability benefits.
  • The disability must be total & expected to last 12 months or end in death.
  • Benefits include monthly payments to the disabled worker, spousal benefits, and children's benefits.


As defined under Social Security benefits, a disability describes an employee who is unable to engage in any occupation. The insured has a disability that is expected to result in early death or is expected to last for a continuous period of 12 months.

Disability, as defined for Social Security purposes, is "the inability to engage in any gainful activity by reason of any medically determinable physical or mental impairment which has lasted, or could be expected to last, for a continuous period of 12 months or result in death".  The impairment must be so severe that the individual is unable to engage in substantial gainful work that exists in the national economy regardless of whether or not such worker exists in the immediate area in which the worker lives.

Once a worker is eligible, he or she must satisfy a five-month waiting period before benefits are payable. Therefore, benefit payments would begin in the sixth month. These benefits are also based on a worker's primary insurance amount (PIA).

Health Insurance Benefits (Medicare)

Medicare is a federal health insurance program comprised of four available parts. This government sponsored program provides health care and other medical benefits for those age 65 and older and those eligible who are disabled.

Medicare is administered by OASDHI and funded or financed through payroll taxes paid through Social Security by employers, employees, and self-employed (i.e., sole proprietor). Part A of Medicare covers Hospital Insurance (HI). Part B, if elected, covers Supplementary Medical Insurance (SMI). Part C and D are Medicare Advantage and the Prescription Drug plan, respectively.


  • Social Security enhances, but does not replace, a sound personal insurance plan.
  • Under Social Security disability coverage, a Fully-Insured individual is one who Has Been Credited with the Appropriate Number of Quarters of Coverage.
  • The Blackout Period begins when the youngest child turns 16 and continues until the spouse reaches age 60, at the earliest. If there are no eligible children with the surviving spouse when the breadwinner dies, the blackout period starts immediately.
  • To qualify, the disability must be expected to last, or have lasted, at least 12 months, or it must be expected to result in death.
  • There are two types of insured statuses that qualify individuals for Social Security benefits: Fully Insured & Currently Insured. Social Security benefits are paid to fully insure individuals.


Qualified Plans Vs Nonqualified Plans

There are many kinds of retirement plans, each designed to fulfill specific needs. The products and contracts they offer provide ideal funding or financial vehicles for both individual plans and employer-sponsored plans. Broadly speaking, retirement plans can be divided into two categories: Qualified plans & nonqualified plans. Qualified plans are those that meet federal requirements and receive favorable tax treatment.

Employer contributions to a qualified retirement plan are considered a deductible business expense, which lowers the business's income taxes. Employer contributions to a qualified plan are not currently taxable to the employee in the years they are contributed. However, they are taxable when paid-out as a benefit (typically when the employee is retired and in a lower tax bracket).

  • Contributions to an individual qualified plan, such as an individual retirement account or annuity (IRA), are deductible from income under certain conditions.

The earnings of a qualified plan are exempt from income taxation until taken out.

Alienation of Benefits

Alienation of benefit involves the assignment of a pension or retirement plan participant's benefits to another person. It is permitted only under exceptional circumstances per IRA rules, such as certain participant loans and certain domestic relations order.

Characteristics of Qualified Employer Plans

An employer retirement plan is one that a business makes available to its employees. Typically, the employer makes all or a portion of the contributions on behalf of its employees and is able to deduct these contributions as ordinary and necessary business expense. The employees are not taxed on the contributions made on their behalf, nor are they taxed on the benefit fund accruing to them until it is actually paid out. By the same token, an individual employee's contribution to a qualified employer retirement plan are not included in the individual's ordinary income and therefore are not taxable.

Employee Retirement Income Security Act of 1974

Many of the basic concepts associated with qualified employer plans can be traced to the Employee Retirement Income Security Act of 1974, commonly called ERISA. The purpose of ERISA is to protect the rights of workers covered under an employer-sponsored plan.

ERISA imposes several requirements that retirement plans must follow to obtain IRS approval as a qualified plan, eligible for favorable tax treatment.

  • This law sets forth standards for participation, coverage, vesting, funding, and contributions.

ERISA also regulates group health insurance in the area of disclosure and reporting. Before the passage of ERISA, workers had few guarantees to assure them that they would receive the pension benefit they thought they had earned. An unfortunate but common plight was the worker who devoted many years to one employer only to be terminated within a few years of retirement and not be entitled to a pension benefit.

Participation Standards

All qualified employer plans must comply with ERISA minimum participation standards designed to determine employee eligibility. In general, employees who have reached age 21 and have completed one year of service must be allowed to enroll in a qualified plan. If the plan provides 100% vesting upon participation, they may be required o complete two years of service before enrolling. New employees must receive a copy of their plan sponsor's latest Summary Pan Description within 90 days after becoming covered by the plan. Church, governmental, and collectively bargained plans are specifically exempt from ERISA regulations.

Coverage Requirements

Under IRS "minimum coverage" rules, a qualified retirement plan must benefit a broad cross-section of employees. The purpose of coverage requirements is to prevent a plan from discriminating against rank-and-file employees in favor of the "elite" employees (officers and highly compensated employees). Their positions often enable them to make basic policy decisions regarding the plan.

The IRS will subject qualified employer plans to coverage tests to determine if they are discriminatory. As mentioned earlier, all qualified employer plans must comply with ERISA minimum participation standards designed to determine employee eligibility. In general, employees who have reached age 21 and have completed one year of service must be allowed to enroll in a qualified plan.

A qualified plan cannot discriminate in favor of highly-paid employees in its coverage provisions or in its contributions and benefits provisions

From 5500 is a disclosure document that employee benefit plans use to satisfy annual reporting requirements under ERISA.

Vesting Schedules

All qualified plans must meet standards that set forth the employee vesting schedule and nonforfeitable rights at any specified time. Vesting means the right that employees have to their retirement funds. Benefits that are "vested" belong to each employee even if the employ terminates employment prior to retirement. An employee always has a 100% vested interest in benefits that accrue from the employee's own contributions to all plans. Benefits that accrue from employer contributions must vest according to vesting schedules established by law.

Funding Standards

For a plan to be qualified, it must be funded. In other words, there must be real contributions on the part of the employer, the employee, or both. These funds must be held by a third party and invested. The funding vehicle is the method for investing the funds as they accumulate.

The exclusive benefit rule states that assets held in a company's qualified retirement plan must be maintained for the exclusive benefit of the employees and their beneficiaries. Under a qualified retirement plan, the survivor benefits can be waived only with a married worker's spouse written consent.

Federal minimum funding requirements are set to ensure that an employer's annual contributions to a pension plan are sufficient to cover the costs of benefit payable during the year, plus administrative expenses.


Qualification standards regarding the amount and type of contributions that can be made to a plan vary, depending on whether the plan is a defined contribution plan of a defined benefit plan. Generally, all plans must restrict the amount of contributions that can be made for, or accrue to, any one plan participant.

The annual addition to an employee's account in a qualified retirement plan cannot exceed the IRS's maximum incidentals limits. A plan is considered "top-heavy" if more than 60% of the plan assets are attributable to key employees as the last day of prior plan year.

Qualified Defined Contribution Plans

A defined contribution plan's provisions address the current amounts going into the plan and identify the participant's vested (nonforfeitable) account. These predetermined amounts contribute to the participant's account accumulate to a future point (i.e., retirement). The final amount available to a participant depends on the total contribution amount, plus interest and dividends.

These are three primary types of defined contribution plans:

  1.  Profit-Sharing Plans
  2.  Stock Bonus Plans
  3.  Money Purchase Plans

Profit-Sharing Plans

Profit-Sharing Plans are established and maintained by an employer and allow employees to participate in the company's profits. They set aside a portion of the firm's net income for distributions to employees who qualify under the plan. Since contributions are tied to the company's profits, it is unnecessary that the employer contributes every year or that the amount of contribution is the same. However, the IRS states that to qualify for favorable tax treatment, the plan must b maintained with "recurring and substantial" contributions. The IRS also states that withdrawals of funds from a profit-sharing plan may be subject to a 10% tax penalty in addition to income taxes if they are made before the age of 59 1/2.

Stock Bonus Plans

A Stock Bonus Plan is similar to a profit-sharing plan, except that the employer's contributions do not depend on profits. Benefits are distributed in the form of company stock.

Money Purchase Plans

Money Purchase Plans provide for fixed contributions with future benefits to be determined. Money purchase plans most truly represent a defined contribution plan. A money purchase plan must meet the following three requirements:

  • Contributions and earnings must be allocated to participants in accordance with a definite formula.
  • Distributions can be made only in accordance with amounts credited to participants.
  • Plan assets must be valued at least once a year, with participants account being adjusted accordingly.

Employee Stock Ownership Plans

Employee Stock Ownership Plans, or ESOP's, are employee-owner programs that provide company's workforce with an ownership interest in the company. Shares are allocated to employees and may be held in an ESOP trust until they retire or leave the company.

Qualified Defined Benefit Plans

In contrast to a defined contribution plan that sets up predetermined contributions, a defined benefit plan establishes a definite future benefits, predetermined by a specific formula. When the term pension is used, the reference typically refers to a defined benefit plan. Usually, the benefits are tied to the employee's years of service, amount of compensation, or both.

For example: A defined benefit plan may provide for a retirement benefit equal to 2% of the employee's highest consecutive five-year earnings, multiplied by the number of years of service. Or the benefit may be defined as simply as $100 a month for life. To qualify for federal tax purposes, a defined benefit plan must meet the following basic requirements:

  • The plan must provide for definite determinable benefits, either by a formula specified in the plan or by actuarial computation.
  • The plan must provide for systematic payment of benefits to employees over a period of years (usually for life) after retirement. Thus, the plan must detail the conditions under which benefits are payable and the option under which benefits are paid.
  • The plan must provide retirement benefits primarily. The IRS will allow provisions for death or disability benefits, but these benefits must be incidental to retirement.

The maximum annual benefit an employee may receive in any one year is limited to an amount et by the tax law.

The appropriate choice of qualified corporate retirement plan (defined contribution or defined benefit) requires an understanding of each plan's operation and characteristics as they relate to the employer's objectives.

Qualified Salary Reduction Plans

Cash or Deferred Arrangements (401 (k) Plans)

Another form of qualified employer retirement plan is known as the 401 (k) plan. Employees can elect to reduce their current salaries by deferring amounts into a retirement plan. These plans are called cash or salary deferral option because employees cannot be forced to participate. They may currently take their income as cash or defer a portion of it until retirement with favorable tax advantages. The amounts deferred are not included in the employees gross income, and earnings credited to the deferrals grow tax-free until distribution. Typically, 401 (k0 plans include matching employer contributions. The maximum annual pretax contribution limit is $19,500.

Tax-Sheltered Annuities (403 (b) Plans)

Another type of employer retirement plan is the tax-sheltered annuity, or 403 (b). A tax-sheltered annuity is a unique tax-favored retirement plan available only to specific groups, of employees. Tax-sheltered annuities may be established for the employees of specified nonprofit charitable, educational, religious, and other 501 (c)(3) organizations, including teachers in public school systems. Such plans generally are not available to other kinds of employees.

Funds are contributed by the employer or by the employees (usually through payroll deductions) to tax-sheltered annuities and are thus excluded from employees current taxable income.

IRC Section 457 Deferred Compensation Plans

Deferred compensations plans for employees of state and local governments and nonprofit organizations became popular in  the 1970s. Congress enacted Internal Revenue Code Section 457 to allow participants in such plans to defer compensation without current taxation as long as certain conditions are met.

If a plan is eligible under Section 457, the amounts deferred will not be included in gross income until they are actually received or made available. Life insurance and annuities are authorized investments for these plans. The annual amounts an employee may defer under a Section 457 plan are similar to those available for 401 (k) plans. 

Before 1962, many small business owners found that their employees could participate in a benefit from a qualified retirement plan, but the owners themselves could not. Self-employed individuals were in the same predicament. The reason was that qualified plans had to benefit employees. Because business owners were considered employers, they were excluded from participating in a qualified plan. 

The Self-Employment Individuals Retirement Act, signed into law in 1962, rectified this situation by treating small business owners and self-employed individuals as employees. This law enabled them to participate in a qualified plan if they chose to do so, just like their employees. The result was the Keogh (or HR-10) retirement plan.

Qualified Plans For Small Employers

Keogh Plans (HR-10)

A Keogh plan is a qualified retirement plan designed for unincorporated businesses (self-employed) that allow the business owner (or partner in a business) to participate as an employee only if the business employees are included. These plans may be set up as either defined contribution or defined benefit plans.

In the first years following he Keogh bill's enactment, there was a great deal of disparity between Keogh plan's rules and those for corporate plans. However, various laws have eliminated most of the rules unique to Keogh plans, thereby establishing parity between qualified corporate empoyer retirement plans and noncorporate plans.

  • Keogh Plans are subject to the same maximum contribution limits and benefit limits as qualified corporate plans.
  • Keogh Plans must comply with the same participation and coverage requirements as qualified corporation plans.
  • Keogh plans are subject to the same nondiscrimination rules as qualified corporate plans; Keogh plans have a maximum contribution of $57,000.

Simplified Employee Pensions (SEPs)

Another type of qualified plan suited for the small employer is the simplified employee pension (SEP) plan. Due to the many administrative burdens and the costs involved with establishing a qualified defined contribution or defined benefit plan, as well as maintaining compliance with ERISA, many small businesses have been reluctant to set up retirement plans for their employees.

SEPs were introduced in 1978 specifically for small businesses to overcome these cost, compliance, and administrative hurdles. Basically, SEP's are arrangements where an employee (including a self-employed individual) establishes and maintains an individual retirement account (IRA) to which the employer contributes. Employer contributions are not included in the employee's gross income.

A primary difference between a SEP and an IRA is the much more considerable amount that can be contributed each year to a SEP. In accordance with rules that govern other qualified plans, SEPs must not discriminate in favor of highly compensated employees in regard to contributions or participation.


A variation of the SEP plan is the salary reduction SEP (SARSEP). SARSEPs incorporate a deferral/salary reduction approach in that the employee can elect to have employer contributions directed into the SEP or paid out as taxable cash compensations. The limit on the elective deferral to a SARSEP is the same as 401(k). 

SARSEPs are reserved for small employers (those with 25 or fewer employees) and had to be established before 1997. As a result of tax legislation, no SARSEPs can be established. However, plans that were already in place at the end of 1996 may continue to operate and accept new employee participants.


The same legislation that did away with SARSEPs also created a new form of qualified employer retirement plan (or SIMPLE). These arrangements allow eligible employers to set up tax-favored retirement savings plans for their employees without having to address many of the usual (and burdensome) qualification requirements. 

SIMPLE plans are available to small businesses (including tax-exempt and government entities) that employ no more than 100 employees who received at leas $5,000 in compensation from the employer during the previous year. To establish a SIMPLE plan, the employer must no have a qualified plan in place. SIMPLE plans may be structured as an IRA or as a 401 (k) cash or deferral arrangement. In addition, the employer will not be eligible for participation in a Simple Plan if he or she already maintains another employer-sponsored plan to which contributions were made (or where benefits have already accrued).

All contributions to a SIMPLE IRA or SIMPLE 401 (k) plan are nonforfeitable, and the employee is immediately and fully vested. Taxation of contributions and their earnings is deferred until funds are withdrawn or distributed.


Both SARSEP and SIMPLE plans allow participants who are at least 50 years old by the end of the plan year to make additional "catch-up" contributions. In much the same way that it encourages businesses to establish retirement plans for their employees, the federal tax law provides incentives for individuals to save for their retirement by allowing certain kinds of plans to receive favorable tax treatment. Individual retirement accounts (IRAs) are the most notable of these plans. Available IRAs include the traditional tax-deductible IRA, the traditional non-tax-deductible IRA, as well as the Roth IRA. Created by the Taxpayer Relief Act of 1997. Roth IRA's require nondeductible contributions but offers tax-free earnings and withdrawals.

Individual Retirement Plans

Traditional IRA

An individual retirement account, commonly called an IRA, is a means by which individuals can save money for retirement and receive a current tax break, regardless of any other retirement plan. Basically, the amount contributed to an IRA accumulates and grows tax-deferred. IRA funds are not taxed until they are taken out at retirement. Depending on the individual's earnings and whether or not an employer-sponsored retirement plan covers the individual, the amount the individual contributes to a traditional IRA may be fully or partially deducted from current income, resulting in lower current income taxes.


Anyone under the age of 70 1/2 who has earned income may open a traditional IRA and contribute up to the contribution limit or 100% of compensation each year, whichever is less. A non-wage-spuse may open IRA and contribute up to the limit each year.

Since 2002, people who are age 50 and older have been allowed to make "catch-up" contributions to their IRAs, above the scheduled annual limit, enabling them to save even more for retirement. These catch-up contributions can be either deductible or made to a Roth IRA.


In many cases, the amount an individual contributes to a traditional IRA can be deducted from that individual's income in the year it is contributed. The ability of an IRA participant to take a deduction for their contributions rests in two factors:

  • Whether or not an employer-sponsored retirement plan covers the participant.
  • The amount of income the participant makes.

Individuals who are not covered by an employer-sponsored plan may contribute, up to the annual limit, to a traditional IRA and deduct from their current income the full amount of the contribution, no matter what their level of income is. Married couples who both work and have no employer sponsored plan can each contribute and deduct up to the maximum each year.

Individuals who are covered by an employer-sponsored plan are subject to different rules regarding the deductibility of traditional IRA contributions.


An ideal funding vehicle for IRAs is a flexible premium fixed deferred annuity. Other acceptable IRA funding vehicles include bank time deposit open accounts, bank certificates of deposit, insured credit union accounts, mutual funds shared, face amount certificates, real estate investment trust units, and particular US gold and silver coins.


Because the purpose of an IRA is provide a way to accumulate retirement funds, there are several rules that discourage traditional IRA owners from withdrawing these funds prior to retirement. By the same token, traditional IRA owners are discouraged from perpetually sheltering their accounts from taxes by rules that mandate when the funds must be withdrawn.

Traditional IRA owners must begin to receive payment from their accounts no later than April 1 following the year in which they reach age 72 (per the Secure Act 2019) if they turn 700 1/2 after December 31, 2019). The law specifies a minimum amount that must be withdrawn every year. Failure to withdraw the minimum amount can result in a 50% excise tax that will be assessed on the amount that should have been withdrawn.

With few exceptions, any distribution from a traditional IRA before age 59 1/2 will have adverse tax consequences. In addition to income tax, the taxable amount of the withdrawal will be subject to a 10% penalty (similar to that imposed one early withdrawals from deferred annuities). Early distributions taken for any of the following reasons or circumstances will not be assessed by 10% penalty:

  • If the owner dies or becomes disabled
  • If the owner is faced with a certain amount of qualifying medical expenses
  • To pay for higher education expenses
  • To cover first time home purchase expenses (up to $10,000 and must not have made a principal home purchase in the last two years)
  • To pay for health insurance premiums while unemployed
  • To correct or reduce an excess contribution

At retirement or any time after age 59 1/2, the IRA owner can elect to receive either a lump-sum payment or periodic installment payments from his or her fund. Traditional IRA distributions are taxed in much the same way as annuity benefit payments are taxed. That is, the portion of an IRA distribution that is attributed to nondeductible contributions is received tax-free. The portion that is attributed to interest earnings or deductible contributions is taxed. The result is a tax-free return of the IRA owner's cost basis and taxing of the balance (interest).

If an IRA owner dies before receiving full payment, the remaining funds in the deceased's IRA will be paid to the named beneficiary.

Suppose the IRA owner is a military reservist called to active duty (between September 11, 2001, and December 31, 2007) for more than 179 days or an indefinite period. In that case, the 10-percent early-withdrawal penalty does not apply. However, regular income taxes will apply.

Suppose the IRA owner is a firefighter, policeman, or an emergency medical technical (EMT) with a pension or retirement plan who retires after age 50. In that case, he or she is also exempt from the penalty tax.

Roth IRA

The 1997 Taxpayer Relief Act introduced a new kind of IRA: The Roth IRA.

Roth IRAs are unique in that they provide for back-end benefits. No income tax deductions can be taken for contributions make to a Roth, but the earnings on those contributions are entirely tax-free when they are withdrawn. An amount up to the annual contribution limit can be contributed to a Roth IRA for any eligible individual. Active participant status is irrelevant.

  • No income tax deductions can be taken for contributions made to a Roth, but the earnings on those contributions are entirely tax-free when they are withdrawn.

An individual can open and contribute to a Roth regardless of whether the individual is covered by an employer's plan or maintains and contributes to other IRA accounts. No more than maximum amount can be contributed to it in any year, for any account combination of account.

Unlike traditional IRAs, who are limited to those under age 70 1/2, Roth IRAs, impose no age limits. At any age, an individual with earned income can establish a Roth IRA and make contributions. However, Roth Iras subject participants to earnings limitations that traditional IRAs do not. High-income earners may not be able to contribute to a Roth IRA since the maximum annual contribution that can be made begins to phase out for individuals whose modified adjusted gross incomes reach certain levels. Above these limits, no Roth contributions are allowed.


Withdrawals from Roth IRAs are wither qualified or nonqualified. A qualified withdrawal is one that provides for the full-tax advantage that Roth's offer (tax-free distribution of earnings). To be a qualified withdrawal, the following two requirements must be met:

  • The funds must have been held in the account for a minimum of five years.
  • The withdrawal must occur because the owner has reached age 59 1/2
  • The owner dies
  • The owner becomes disabled
  • The distribution is used to purchase their first home


A nonqualified withdrawal is one that does not meet the previously discussed criteria. The result is that distributed Roth earnings are subject to tax. This would occur when the withdrawal is taken without meeting the above requirements, and the amount of the withdrawal exceeds the total amount that was contributed.

Since Roth contributions are made with after-tax dollars, they are not subject to taxation again upon withdrawal. The only portion of a Roth withdrawal that is subject to taxation earnings, and only when those earnings are removed from the account without having met the above requirements. If the owner of the Roth IRA is younger than 59 1/2 when the withdrawal is taken, it will be considered premature, and the earnings portion will also be assessed a 10% penalty.


Unlike traditional IRAs, Roth IRAs do not require mandatory distributions. There is no minimum distribution requirement for the account owner. The funds can remain in the account as long as the owner desires. In fact, the account can be left intact and passed on to heirs or beneficiaries.

Spousal IRA

Persons eligible to set up IRAs for themselves may create a separate spousal IRA for a nonworking spouse. They can contribute up to the annual maximum to the spousal account, even if the working spouse is in an employer-sponsored plan.

Conduit IRA

A conduit IRA is a holding tank for funds that initially came from a qualified plan and are on their way to another qualified plan. No withholding tax is necessary unless any of the funds are distributed directly to the individual.

Rollover IRA

Usually, benefits withdrawn from any qualified retirement plan are taxable the year in which they are received. However, specific tax-free "rollover" provisions of the tax law provide some degree of portability when an individual wishes to transfer funds from one plan to another, specifically to rollover IRA.

Essentially, rollover IRAs provide a way for individuals who have received a distribution from a qualified plan to reinvest the funds in a new tax-deferred account and continue to shelter those funds and their earnings from current taxes. Rollover contributions to an IRA are unlimited by dollar amount. 

Rollover IRAs are used by individuals who, for example, have left one employer's plan. Another example would be those who had invested funds in an individual IRA of one kind and want to roll over to another IRA for a higher return rate. Also, a distribution received from an employer-sponsored retirement plan (or from an IRA) is eligible for a tax-free rollover if it is reinvested in an IRA within 60 days following receipt of the distribution and the plan participant does not actually take physical receipt of the distribution and if the plan participant does not actually take physical receipts of the distribution. A partial distribution may be rolled over from one IRA or eligible plan to another IRA. However, if a partial rollover is executed, the part retained will be taxed as ordinary income and subject to a 10% early distribution penalty.

Only the person who established an IRA is eligible to benefit from the rollover treatment-with one exception. A surviving spouse who inherits IRA benefits or benefits from the deceased spouse's qualified plan is eligible to establish a rollover IRA in the surviving spouse's own name. Assets  passing to a surviving spouse generally are not subject to estate taxes at the time of death due to the Unlimited Martial Deduction. Note that tax law now allows non-spousal beneficiaries to take IRA proceeds over their lifetimes, plus the lifetimes of their oldest named beneficiary.

Any rollover must be made directly from one IRA to another IRA, or it will be subject to a 20% withholding. This is true even if the rollover occurs within the 60-day limit. The key here is the word directly. To escape the withholding rate, the rollover must occur without the plan's funds being in the recipient's control for even an instant.

Suppose such control does occur, and 20% is withheld. In that case, the recipient must make up this amount out of other funds, or the amount withheld will be subject to income taxation and possibly a penalty for premature distribution. Of course, the amount withheld is applied toward the tax liability, if any, of the money distributed from the fund. The withholding rule also applies to a trustee-to-trustee transfer for rollover funds.

Pension Protection Act

The Pension Protection Act of 2006 embodied America's pension laws most sweeping reform in over 30 years. It improves the pension system and increases opportunities to fund retirement plans.

The Act encourages workers to increase their contributions to employer-sponsored retirement plans and helps them manage their investments. For example, automatic enrollment is a means of increasing participation in 401(k) plans, especially among young workers entering the workforce.

The Act also provides for automatic deferral into investment funds and automatic annual increases in employees salary deferral rates beginning in 2008. Since 2007, plan sponsors can offer fund-specific investment advice to participants through their retirement plan providers or other fiduciary advisers. Counseling in person is also allowed under strict guidelines.

Education Savings Plans

Education IRAs

Education IRAs (also referred to as Coverdell Education Savings Account) are also available where an investor can make nondeductible contributions of up to $2,000 per child under age eighteen. These funds saved can be used for primary and secondary school expenses (i.e., tuition, books) in addition to higher education feed (i.e., collage). Any funds leftover (i.e., if a child does not attend college) may be rolled over into another Education IRA before age 30.

Section 529 Plans

The Economic Growth and Tax Relief Act of 2001 created the qualified 529 savings plan. Section 529 plans are state-operated investment plans that give families a federal tax-free method to save money for college and other qualified, port-secondary higher education expenses (i.e., vocational school, graduate school, or trade school). There are two types of 529 plans. A college savings plan allows parents to use their plan funds for college expenses at any college. A prepaid tuition plan allows parents to "lock-in" future tuition at in-state public colleges at current prices. 

Like a Roth IRA, earnings from 529 plan are exempt from federal taxes as are any withdrawals as long as they go toward playing college costs. Some States waive State taxes for residents while others allow deductions on contributions. Qualified expenses include but are not limited to tuition, room and board, books, and supplies.

There is no direct limitation on the amount of money that can be contributed to a 529 plan. However, a 529 plan contribution is considered a gift and is therefore subject to gift taxes and the rules regarding estate taxes and the estate tax exclusion.

Each person may contribute up to $14,000 without triggering gift taxes ($70,000 allowed for five years). If funds are withdrawn for purposes other than education (i.e., unqualified distributions), the earnings are subject to a 10% penalty and federal income tax. States may assess their own penalties. Grandparents can use this plan to make gifts to grandchildren. The amounts contributed by grandparents are excluded from their estate.

The owner of a plan may switch investment options within the same plan once per year. A rollover is permitted from one 529 plan into another once per year as well. Savings are treated as a parental asset when aid is determined. Still, only 5.6% or less of the account's value is factored into calculating the expected family contribution (EFC) for each academic year. The account holder controls the money for the account's life, even after the beneficiary reaches age 18. Beneficiaries may also be charged at any time.

Nonqualified Retirement Plans

If a plan does not meet the specific requirements set forth by the federal government, it is termed a nonqualified plan and, thus, is not eligible for favorable tax treatment.

For example; Bill, age 42, decides he wants to start a retirement fund. He opens a new savings account at his local bank, deposits $150 a month in that account, and vows not to touch that money until he reaches age 65. Although his intentions are good, they will not serve to "qualify" his plan. The income he deposits and the interest he earns are still taxable every year.

Employers generally provide nonqualified retirement plans to highly paid or key employees, or directors and officers of a firm. The contributions to such plans are not tax-deductible since the employer makes no effort to satisfy the qualification requirements under the Internal Revenue Code (i.e., IRC) or ERISA for tax-favored treatment of qualified plan costs or benefits. 

Providing this type of additional compensation to an employee allows the firm to attract and retain key employees services. Common types of nonqualified plans include nonqualified deferred compensation plans, supplemental executive retirement plans, and incentive compensation plans. 

For instance, in  a nonqualified deferred compensation plan, compensation for an employee's services is postponed until retirement. Generally, the employee will not pay taxes on the differed amounts until they are received. The employer cannot deduct the deferred until they are actually received by the employee, usually at retirement. Nonqualified plans may be funded or unfunded.

  • A funded plan is one where the employer maintains assets in some sort of trust or escrow account as security for the promise of future benefit payment. 
  • An unfunded plan exists when no actual fund or assets have been designated to fund the plan. Therefore, the employee is relying on the unsecured promise of the employer.

Important Notes

  • Keogh Plans were designed to provide pension benefits for self-employed individuals.
  • Roth IRA does NOT qualify for a federal income tax deduction. but the earnings on those contributions are entirely tax-free when they are withdrawn.
  • After you receive funds from your IRA, you have 60 days to complete the rollover to another IRA. This is to avoid being taxed (as current income).
  • A distribution received from a Traditional IRA is eligible for a tax-free rollover if it is reinvested in another IRA within 60 days following receipt of distribution and in the plan participant does not actually take physical receipt of the distribution.
  • A temporary retirement plan will not qualify for favorable tax treatment.
  • Interest Earned on a Traditional IRA is taxed Upon Distribution at ordinary tax rates earnings are taxable when withdrawn.
  • To be able to make tax-free withdrawals from a Roth IRA, an account owner should be AT LEAST age 59 1/2 and have held the account for at least 5 years.
  • A Local Electric Supply company with 12 employees would be subject to ERISA [Employee Retirement Income Security Act of 1974].
  • An individual can begin to receive distributions from an IRA at age 59 1/2 without a 10% tax penalty.
  • Contributions made to a Roth IRA [individual retirement account] are not tax deductible.
  • A Defined Contribution Plan is considered a Tax-Qualified Plan.
  • A Qualified Plan does NOT ALLOW the employee to make unlimited contributions.
  • GAINS are the Taxable Portion of the Distributions of Qualified Plans.
  • When a Beneficiary Inherits a Traditional IRA, an Income Tax is paid when money is withdrawn.
  • Withdrawing funds from a Qualified Plan for the purpose of Stocks or other Securities would trigger a 10% tax penalty.


Determining the Proper Amount of Life Insurance

Planning for the income needs of survivors is extremely important. The planning process involves:

  1. Information Gathering Including Personal Information (i.e., Ages, Health History) and financial information such as wages, personal assets, investments and earnings, pension plans and savings.
  2. Identifying and prioritizing the client's objectives
  3. Analyzing the client's current financial condition
  4. Developing and Implementing a Plan
  5. Periodically Reviewing the plan.

Life Insurance Proceeds will often be used to replace the salary or the lost services of the deceased. The producer must also help the proposed insured and family determine the proper amount of life insurance when considering what amount of capital should be retained or available at death and if these available funds will be sufficient to protect against a forced liquidation of property.

Traditionally two primary approaches can be used to determine how much life insurance an individual or family needs; The Human Life Value Approach and The Needs Approach. Either of these approaches may be utilized successfully, although the human life value approach does not consider those who receive a financial benefit from the individual's continued life.

Human Life Value

The human life value approach is a capitalized value of an individual's net future earnings. In other words, it looks at the potential lost earnings of a person as a measure of how much insurance to purchase. A person's future earning capacity ends abruptly when they die prematurely. Therefore, to determine how much life insurance is needed to protect this individual's dependents, we may multiply the projected earned income per year by the number of years until retirement.

Generally, the present value of the individual's projected earnings minus expenses (i.e., income taxes and cost of living) are multiplied by the years until retirement age. This formula provides an approximate coverage amount that is needed. Therefore, determining the value of an individual's earning potential over a period of time is know as the Human Life Value Approach.

The Human Life Value Approach calculates the amount of money a person is expected to earn over his lifetime to determine the face amount of life insurance need, thereby placing a dollar value on an individual's life.

Needs Approach

The Needs Approach is used when the amount of Life Insurance needed is based upon the individual's (family's) financial goals and objectives. Therefore, education fund goals, emergency funds, bequests, charitable gifting, or retirement income goals of a spouse will influence the amount of coverage needed. This formula suggests that all family members ages, wages, and health history need to be reviewed.

Purchasing Life Insurance is a charitable gift also has its tax advantages. For instance, if the owner of a life insurance policy transfers all or a part of an existing whole life policy to a charitable organization, he or she will receive an income tax deduction based on the cash value of the policy at the time of the transfer. Additionally, if a new policy is purchased and the charity is named owner and beneficiary, the purchaser's future premium payments are tax-deductible (i.e., Tax-deductible gift).

The Needs Approach will focus on determining lump sum needs and will utilize all the costs associated with death (i.e., postmortem costs) plus financial objectives to arrive at a person's or family's total capital needs. Then, liquid assets of the person are calculated. Liquid asset include savings, pension or profit-sharing benefits, life insurance proceeds, Social Security retirement income, interest form bons, dividends from mutual funds or stocks, rental income, and other income the person is entitled to.

It is specially important to consider Social Security since no retirement income is provided t survivors during the so-called "blackout period".

The Blackout period is the period of time from the insured's death until the surviving spouse is permitted to receive retirement income benefits. However, benefits are provided for other dependents (i.e., children) during the blackout period until the youngest child reaches age eighteen (18). By subtracting liquid assets from total capital needs, the individual will arrive at the approximate amount of

Other Approaches

  •  The "multiple earnings method" selects a number of years to replace the insureds annual salary. For example, five times a person's annual salary.
  • The "interest-only method" determines how much insurance is needed to maintain after-tax family consumption levels if the insurer holds the principle for future payments.
  • The "single needs method" identifies the amount of insurance needed based upon a specific need (i.e., loan or debt, education funds, death taxes, etc.).
  • The "capital needs analysis" determines the immediate cash needs of an individual or family, such:
  • Final Expenses, medical expenses associated with death, probate costs, cost of living expenses, debt elimination, an emergency fund, education funds;
  • Federal and State death taxes, which must be paid within six months of the death
  • Continuing income needs (i.e., readjustment income, dependence period income, life income for a survivor and retirement income).
  • The seat "of the pants" method arbitrarily selects the amount of insurance necessary.

Individual Uses For Life Insurance

Life insurance provides for the immediate creation of funds payable to a beneficiary when an insured person dies. We all purchase life insurance for a variety of reasons including but not limited to:

  1. Final Expenses
  2. Estate Protection & conservation
  3. Funds for survivor protection & security
  4. Education Expenses
  5. Funds to Pay of Debt (house)
  6. Supplement Retirement Income
  7. Charitable Contributions
  8. Disability, Illness and Emergency Funds
  9. Accumulate Cash (for Liquidity Purposes)

The personal uses of life insurance are similar to an related to the costs associated with death that were previously reviewed. Therefore, life insurance is used for survivor protection, estate creation, cash accumulation, liquidity, and estate conservation (to pay off estate taxes that are incurred). A life insurance producer should consider all of the uses when working with a client.

A life insurance policy is piece of property, just like a house. Therefore, this property's value must be included in the owner's estate at death and may be estate taxable. The most significant advantage of life insurance as a property is that it creates an immediate estate when an insured dies.

A life insurance policy is a piece of property just like a home. Therefore, the value of this piece of property must be included in the owner's estate at death and may be estate taxable. The biggest advantage of life insurance as property is that when an insured dies, the policy creates an immediate estate.

Business Uses Of Life Insurance

Business Uses Policy Loans

Policy loans can be used for many business needs, such as funding buy-sell agreements, differed compensation for key employees, or split-dollar arrangements.

Key Employee Life Insurance

The principal reason that key employee insurance was developed is to compensate a business for the loss of earnings (or increase in expenses) due to a key employee's death (or disability). This type of plan is also referred as key person insurance.


A firm is sometime dependent upon a key person whose management skill, technical knowledge & experience make them an invaluable asset of the business. In a sense, the company is dependent on this key person for its success. The proceeds of a life insurance policy covering a key employee will provide the business with the necessary funds to find and train a new employee and continue the business without further interruption. Key employee insurance covers an employee and not the business owner.


Key employee insurance is a common illustration of third-party ownership. The business possesses an economic and financial interest in its key employee. Therefore, insurable interest is present in such a relationship.

The business's potential economic loss can be protected against a key employee's death if the business is made the beneficiary of the life insurance policy. Therefore, the policy will indemnify the business for financial loss due to the covered key employee's death.  The business will be indemnified for its loss of the key manager, director, or officer, and policy proceeds will help it continue while a replacement is sought. The employer or business is the policy owner, and the employee is the insured. The situation involves third-party ownership. Since the employer is the policyholder, it possesses all ownership rights, including the right to name the beneficiary.


The corporation, firm, partnership, or sole proprietorship will be the applicant, policy owner, premium payor, and the beneficiary (i.e., third-party ownership). Therefore, the business possesses the owner's rights under the policy, such as naming or changing the beneficiary, borrowing from the cash value, receiving dividends, or assigning benefits.

Whole life or universal life contracts are commonly used to fund a key employee life insurance plan. Term life insurance may be used for short term needs. As "Tax Facts" states, premium paid by a business for key employee life insurance are generally not tax-deductible. In addition, none of the death benefit paid is taxable when a key employee dies. The death proceeds will not be included in the deceased employee's estate as long as they have no ownership incidents in the contract. 

Remember that a Key Employee or Key Person life insurance plan does not provide life insurance coverage on the employer's life. It covers the key person's life an indemnifies the employer (i.e., the business) if the key employee dies.

Business Continuation Plans

Sole proprietorships, corporations, or partnerships are faced with the challenge of business stability and continuation following the death of one ore more of its owners or partners. The deceased individual's surviving family holds a personal and economic interest in the business and, more specifically, the deceased's share of the firm.

The business partners wish to make sure the deceased partner's survivors will receive funds equal to their financial interest in the firm if one of them dies. Therefore, partners or members of a corporation, or a sole proprietor and a key employee will enter into a formal business continuation agreement known as a buy-sell agreement.  Buy-sell agreements can be funded for use in a sole proprietorship, partnership, or closely-held corporation.


A buy-sell agreement is a legal agreement that provides for:

  1. An Orderly Continuation [Transfer of the Business]
  2. An amount of Money to be Paid [to Deceased's Survivor]

Funds to be paid to the surviving family may come from life insurance. Life insurance may be purchased to fund a buy-sell agreement.


There is a two-step business continuation plan to keep the business running after the proprietor's death, whereby the employee takes over management of the business.

Buy-Sell Plan: an attorney drafts a buy-sell plan stating the employee's agreement to purchase the proprietor's estate and sell the business at a price that has been agreed upon beforehand.

Insurance Policy: the employee purchases a life insurance policy on the life of the proprietor. The employee is the policyowner, beneficiary, and pays the premiums. Upon the proprietor's death, funds from the policy are used to buy the business.


In a partnership, the law states that any change in its membership will cause its dissolution. Therefore, if a partner dies, the partnership ends. The remaining partners must now wind up the business and pay the deceased partner's estate an amount equal to the deceased's fair share of the business's liquidated value. If a forced sale results where assets are sold for less than they are worth, this fair share of the business may be less than anticipated. Therefore, life insurance, which funds the buy-sell agreement, will help maintain the business's value.

A buy-sell agreement used in a partnership binds the surviving partners to purchase the deceased partner's partnership interest at a prearranged price identified in the agreement. The agreement obligates the deceased partner's state to sell its interest to the surviving partner(s). This agreement permits the surviving partners, officers, or stockholders, to maintain control of the business. This agreement, supported by life insurance, is designed to protect he business or firm.

There are two types of partnership buy-sell agreements. An entity plan specifies that the partnership is obligated to buy out the deceased partner's ownership interest. 

If the partnership consists of four partners, the partnership will purchase, own, and pay for a life insurance policy covering each of the four partners. In other words, four policies will be purchased to fund the agreement. Policy proceeds will be paid to the partnership, which will then be used to purchase the deceased partner's interest. A cross-purchase plan specifies that the agreement will exist between the partners themselves and not between the partnership and the partners as in the entity plan.

For Example; If the partnership consists of four partners, each partner will purchase, own, and pay for a policy covering each of the other partners. In this case, there would be a total of twelve policies.


Unlike a partnership, a close corporation (i.e., incorporated family business) is legally separated from its owners. It exists after one or more owners dies. Buy-sell agreements used for corporations may also be funded by life insurance. An entity plan funded by life insurance used for corporations is known as stock redemption plan. The corporation is bound to purchase the stock of the deceased stockholder at a prearranged price. If funded by life insurance, the corporation buys a policy on each of the stockholder's lives.

A cross-purchase plan financed by life polices involves each stockholder buying policies on each of the stockholders. Both corporation plans function similarly to agreements available to partners and partnerships. An estate comprised mostly of stock that possesses potential estate tax problems(i.e., forced sale) may utilize a 303 redemption funded by life insurance. The stock's value must represent at least 35% of the deceased's adjusted gross estate to qualify to qualify for this type of plan.

Small corporations often purchase life insurance on their lives of significant stockholders to fund a buy-sell agreement.

Employee Benefit Plans

Split-Dollar Plan (SDP)

This type of plan is a funding method and not a specific type of life insurance policy. It is characterized by an arrangement between an employer and an employee. The plan can only be funded with whole life, cash value, or continuous-premium life insurance. The death benefit is a split, as is the cash value (i.e., living benefit). In some cases, the premium may be split as well.

The purpose of a split-dollar plan is to join the needs of one person (i.e., the employee) with the premium paying ability of another party (i.e., employer). An SDP can provide an employee with life insurance protection that he cannot afford on his own. The employer may discriminate when providing such planes. In other word, the employer can provide an SDP for any employee he or she chooses (does not have to provide for all).

The most common type of SDP is an employer providing funds to pay the part of each annual premium equal to the annual increase in cash value. The employee pays the balance. For example, if the annual premium was $500 and the cash value increase was $420 after the premium was paid, the employer pays $420 and the employee $80. 

The employer is entitled to receive death proceeds in an amount equal to the policy's cash value. The employee's beneficiary will receive the balance of the policy proceeds. SDPs can also be used among family members (i.e., parent/child) or stockholder in a corporation. Other split-dollar plan variations include single bonus plans, reverse split-dollar plans, and employer (non-contributory) pay-all plans.

Deferred Compensation Funding

Deferred compensation is an executive benefit an employer can use to pay a highly paid employee at a later date, such as upon disability, retirement, or death. Deferred compensation funding generally refers to non-qualified retirement plans. In other words, plans that do no receive the same tax advantages as qualified plans, according to the Internal Revenue Code. These arrangements are generally between an employer and employee where compensation is paid to the employee later. Some employers use cash value life insurance or annuity products to provide promised funds.

Salary Continuation Plan

Salary Continuation Plan works the same as deferred compensation except that the employer funds the plan rather than the employee. The employer establishes an agreement whereby an employee will continue to receive income payments upon death,  disability, or retirement.

Corporate-owned Life Insurance

Corporate-Owned Life Insurance (COLI) is generally treated as a deductible business expense. The proceeds are paid tax-free up to a certain level (i.e., $50,000). If more than this amount is provided to an employee, the excess premium used to purchase must be reported by the employee as taxable income.

Some insurers now include a "charge of insured provision" in life insurance  policies utilized for business purposes, which allow for a change of insured. This provision is useful primarily in corporate-owned life insurance policies. When an employee covered by the policy either retires or his employment is terminated, the employer may change the name of the insured with that of a new or replacement employee, subject to insurability requirements. The availability of his provision eliminates the need to write a completely new policy that would result in additional policy fees, commissions, or other expenses that are incurred when purchasing new life insurance.

Corporate-Owned Annuities

Contributions to a corporate annuity are taxed differently than individually owned annuities. If a corporation owns an annuity, it must name a "natural person" as an annuitant. Sometimes this natural person referred to as the "measurable life". If a natural person is named as an annuitant, the interest credited to the annuity each year is generally not taxable (i.e., tax-deferred). If a non-natural entity is named an annuitant (i.e., corporation), interest earned is taxable as ordinary income in the year credited.

There is an exception to this non-natural person rule. Suppose the annuity is held by a trust, corporation, or other "non-natural person" as an agent for a natural person (i.e., a human being). In that case, interest earned continues to be tax-deferred. Other expectations to this rule include but are not limited to:

  • An annuity contract that is acquired by a person's estate following the death of that person.
  • An annuity contract that is held under a qualified retirement plan, a TSA, or an IRA.
  • An immediate annuity contract purchased with a single premium, with periodic payments to commence within a year.

Executive Bonus Plan

Also referred to as a Section 162 bonus plan, an executive bonus plan is a non-qualified employee benefit arrangement. An employer pays a compensation bonus to a selected employee who uses the bonus payment to pay the premiums on a life insurance policy covering his or her life. The employee owns the policy personally.

The employer may use the amount of the bonus as a tax deduction, and the employee, whether he or she uses it to buy insurance or not, must include the amount of the bonus in his or her gross income. In the event of the employee/insured's death, the policy's proceeds are paid tax-free to the designated beneficiary.

Any policy withdrawals, surrenders, or loans made by the employee are taxed as they would be if the employee had purchased the policy without the benefit of the bonus arrangement.

Important Notes

  • Covering Entry level employees with life insurance to protect the business is not an appropriate business use.
  • The Human Life Value calculator helps you assess the Financial Loss your Family would incur if you were to die today.
  • The Human Life Approach predicts an individual's future earnings potential and determines how much of that amount would be devoted to dependents.
  • When Individuals purchase life insurance To Enable Their Heirs to Pay Estate Taxes, this is called Estate Conservation.

* 1935 Social Security Act : Created to provide for United States citizens general welfare who are 65 years of age and older. The Act was enacted by the Senate & House of Representatives of the United States to enable individual states to make more adequate provisions for furnishing financial assistance to the aged, blind, dependent and crippled children, maternal and child welfare, publish health and to establish more adequate provisions for the administration of their unemployment compensation laws,

* 1944 U. States v. SEUA : In the Southeastern Underwriters Association case, the Supreme Court ruled that the insurance industry is subject to a series of Federal Laws, many of which conflicted with existing state laws. As such, insurance is a form of interstate commerce to be regulated by the federal government.

* 1945 McCarran-Ferguson Act : This law made it clear that the states continued regulation of insurance was in the publics best interest. However, it also made possible the application of federal antitrust laws to the extent that [The insurance business] is not regulated by state law.

* 1958 Intervention by the FTC : In 1958 the Supreme Court held that the McCarran Ferguson Act disallowed such supervision by the FTC, a federal agency. Additional attempts have been made by the FTC to force further Federal Control, but none have been successful.

* 1959 Intervention by the SEC : The Supreme Court ruled that Federal securities laws applied to insurers that issued variable annuities and, thus, required these insurers to conform to both SEC and state regulations. The SEC regulated variable life insurance.

* 1868 Paul v. Virginia : This case, which the U.S. Supreme Court decided, involved one state's attempt to regulate an insurance company domiciled in another state.

* 1970 Fair Credit Reporting Act : Requires fair and accurate reporting of information about consumers, including applications for insurance. Insurers must inform applicants about Any Investigations that are being made upon completion of the application.

* 1994 U. States Code (USC) Section 1033 & 1034.
According to 18 U.S.C. 1033 & 1034 : It is a criminal offense for an individual who has been convicted of a felony involving dishonesty or breach of trust to willfully engage or participate (in any capacity) in the business of insurance without first obtaining a "Letter of Written Consent to Engage in the Business of Insurance" from the regulating insurance department of the individual's state of resistance.

* 1999 Financial Services Modernization Act. :  In 1999 Congress passed the Financial Services Modernization Act, which repealed the Glass Steagall Act. Under this new legislation, commercial banks, investment banks, retail brokerages and insurance companies can now enter each other's lines of business.

* 2001 Uniting & Strengthening America by Providing Appropriate Tools Required to Intercept & Obstruct Terrorism Act. : The Patriot Act, which amends the Bank Secrecy Act (BSA), was adopted in response to the September 11, 2001, terrorist attacks. The Patriot Act is intended to strengthen U.S. measures to prevent, detect, and deter terrorists and their funding. The act also aims to prosecute international money laundering and the financing of terrorism. These efforts include anti-money laundering (AML) tools that impact the banking, financial, and investment communities.

* 2003 Do Not Call Implementation Act. : The Do Not Call Registry allows consumers to include their phone numbers on the list to which telemarketers cannot make solicitation calls.

* 2010 Patient Protection & Affordable Care Act (PPACA) : Often shortened to the Affordable Care Act (ACA), it represents one of the most significant regulatory overhauls and expansions of health insurance coverage in U.S. history.

Personal Notes From: Michigan Pre-licensing Education - Life, Accident and Health Insurance course has been approved by the Michigan Department of Financial Services as meeting the mandatory 20-hour requirement for Life and 20-hour Requirement for Health | XCEL Solutions LLC. Provider ID#: 0950 Course ID#: 60731/60732

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