Life Insurance
In the natural course of business, a Company will commonly take out a life insurance policy on a key employee to protect the Company should the key employee unfortunately pass away. The key employee could in fact be the business owner. In addition to providing key person protection for the business, if Universal Life is used, the same insurance policy could be used as an employee retention tool or, in the case of the owner, a wealth accumulation tool.
Here's how it works. The Company and key employee set up a shared ownership Universal Life agreement. Either the business or the key employee could own the policy; to completely avoid any tax consequences at retirement key person ownership is usually recommended. Under the shared ownership agreement, the Company is the beneficiary of and pays for the basic life benefit of the life insurance policy. The key employee makes deposits to the account value. The funds that the key employee deposits to the policy are invested and grow tax free.
If the key employee unfortunately passes away, the Company will receive the tax free death benefit to cover the business costs incurred due to the loss of the key employee. The accumulated account value will pass tax free to the key employee's chosen beneficiaries.
At retirement, when the business typically has no further need for the policy, the key employee retains ownership of the policy. Ideally the policy has been "paid up" by the Company and no further premium payments are required after retirement. The store of wealth that has built up tax free in the policy can then be used as a source of retirement funding for the retired employee either by taxable withdrawals (presumably at a lower retirement marginal tax rate) or by collateral assignment. The beneficiary of the policy will no longer be the Company so the face value of the policy can now be used for estate planning purposes.
End result ... the Company gets key person insurance; the key employee has a tax deferred retirement savings plan and the benefit of a fully paid up life insurance on their life at retirement.
