Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

Estate Planning

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• A Survivor’s Income Benefit plan also called a Death Benefit Only plan (DBO) is an agreement between a corporation and an employee in which:─ Corporation agrees that if the employee dies before

retirement, it will pay a specified amount or amount determined by a specified formula to the employee’s spouse or another designated class of beneficiaries, such as the employee’s children

– The amount may be a multiple of salary, such as two, three, or five times the average base pay in the three years preceding death

What Is A Survivor’s Income Benefit (SIB) Plan?

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

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• A survivor’s income benefit plan should not be linked in any way with a plan that provides any kind of post-retirement annuity benefits

What Is A Survivor’s Income Benefit (SIB) Plan?

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

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• When additional income is desired for the family of an individual in a high estate tax bracket

• When an employer would like to provide a selected employee(s) with an impressive fringe benefit over and above that provided under a qualified retirement plan

When Is Use Of An SIB or DBO Plan Appropriate?

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

Estate Planning

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• When a client presently covered under a split dollar arrangement is experiencing rapidly-increasing economic costs and has run into Sarbanes-Oxley issues, or the split dollar arrangement has been terminated – The split dollar plan could be converted into a survivor’s

income benefit plan, so that the security could be continued without the income tax burden

When Is Use Of An SIB or DBO Plan Appropriate?

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

Estate Planning

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• When a corporation would like to provide an immediate death benefit for the family of a young employee, which could later be coupled with a retirement benefit

– By changing the SIB at retirement to a nonqualified deferred compensation plan

When Is Use Of An SIB or DBO Plan Appropriate?

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

Estate Planning

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Example:– Corporation as an inducement to its Senior Executive makes a

legally binding promise that if she should die while an executive for the corporation:

• The corporation will pay her two children a benefit of three times her average annual base salary for the three years prior to death, up to a maximum of $500,000

• Payments to be made in equal annual installments over 10 years (assume $50,000 per year)

– Assume the corporation is in combined 40% income tax bracket– The corporation can finance its obligation by purchasing a life

insurance policy on the executive’s life• The policy would be owned and payable to the corporation

How Is It Done?

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

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Example (cont’d):– At executive’s death the corporation uses the proceeds to

purchase $500,000 of tax-free municipal bonds• Assuming the bonds earn 8%, net income form the bonds would

be $40,000 per year• Corporate cash inflow would be $40,000• Corporate cash outflow would be $50,000 - $20,000 (40% tax

deduction) = $30,000• Corporation has a positive net inflow for the 10 years of $10,000

per year = $100,000 surplus + $56,455 interest earned at 8% • The surplus is probably enough to reimburse the company for its

costs, the use of its money, and any administrative expenses it may have incurred

How Is It Done?

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

Estate Planning

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• The premiums that the corporation pays on the life insurance policy covering the insured employee are not deductible

• Life insurance proceeds received by the corporation at the employee’s death are income tax free. Proceeds may be subject to AMT

• Payments made by the corporation to the designated beneficiaries are deductible if and to the extent that– such payments represent reasonable compensation for services that the

employee rendered, and– the plan serves a valid business purpose

Tax Implications – Employer

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

Estate Planning

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• With a properly drafted plan, none of the death benefit of an SIB plan will be includable in the covered employee’s estate

• Payment of premiums by the corporate employer will not be income to an employee

• IRS now agrees that when the taxpayer and his employer enter into a DBO plan, there is no taxable gift to the beneficiary, either at the time when the plan is entered into, or upon the death of the employee

Tax Implications – Employee/Beneficiary

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

Estate Planning

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• Payments received from a corporation by beneficiaries will be treated the same as salary (deferred compensation)

Tax Implications – Employee/Beneficiary (cont’d)

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

Estate Planning

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• Determine whether the employee’s spouse has a community property interest in the survivor’s income benefit, especially in the event of divorce, subsequent remarriage, or death

• In the case of death,– many states and the IRS consider the SIB plan a property

right– written consent is necessary, if a spouse has a community

property interest, in order to dispose of this personal property right to a third party beneficiary

Issues In Community Property States

Survivor’s Income Benefit Plan Chapter 53Tools & Techniques of

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• In the case of divorce, there is no definitive answer, however,– At the time of the proceeding there are no current property

interests that can be divided equally between the spouses,

– The possibility of payment is remote, and

– The present value of the benefit is difficult to calculate

Issues In Community Property States