You'll learn from experience the amount of insurance to recommend, and for whom. Each situation will be different. However, in these cases it's probably smart to base insurance face amounts on a money-purchase approach, that is, the amount of insurance which can be provided by the dollars available for premiums. The income statement provides a guide, since a portion of retained earnings might be available for business life insurance premiums. Although the income statement can spotlight the need, it may still be necessary to calculate some balance sheet ratios to determine the upper limits of premium dollars available.
The profitability test might suggest a deferred compensation plan. If your clients operate a C corporation, they're faced with the double-taxation dilemma. The corporation is taxed at corporate rates on its earnings, whether distributed or retained. If earnings are retained by the business, the owners receive none of their return in cash, unless they take a salary increase that is taxable.
When a corporation has a high return on investment, one way for owners to gain some tax-favored benefit is through an insured deferred compensation program. Even though premiums are not deductible by the corporation, payment of benefits are deductible by the corporation and are taxable to the owner at retirement, when he or she may be in a lower personal tax bracket.
A high return on investment might also suggest a split-dollar proposal, and for the same reasons. Tax-deferred corporate dollars can be used to provide a personal benefit. The alternative is for the corporation to pay higher salary and bonuses, which are shrunk in the hands of the recipient by income taxes. In most cases, the tax consequences of higher salary pale in comparison to a split-dollar plan.
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