DEDUCT IT!Tax-Deductible Life Insurance Strategies for Businesses

July 2010MKTG-OC-912 Insurance Professional Use Only. Not for Use with the Public.

Many Business Owners Face Issues that May Threaten the Future of Their Business or Family:

Retirement planningEstate planningProperty & casualty insuranceEmployee benefitsPost-retirement medical expenses

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Deductions Can Be Difficult to Find for Business Owners

Not Available:Employer Owned Life Insurance

IRC Section 264(a)Nonqualified deferred compensation

May Not Make Financial Sense

Executive bonus arrangements

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Current income tax deductions may be available for certain strategies…

Keep in mind:Strategy must fit the needTax deduction must not be the primary motivation for the sale

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Captive Insurance

Companies

Qualified Plans

- Defined Benefit -Defined Contribution

Permanent Benefit

Section 79 Plans

Executive Bonus

Arrangements

419(e)Plans

What Strategies MayStill Provide a CurrentTax-Deduction?

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Deduct It! BrochureHelps You Explore the Available Strategies with a Client

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Case Study #1

• Jane Andrews• Age 52• Married with 3 children

• Owner of Andrews’ Fruits• Small fruit & vegetable wholesaler• C-Corporation• 10 employees

• 8 of which are full time

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What Jane Currently Has

• 401(k) Profit Sharing Plan• Allows employee elective deferrals• Company profit sharing component

• 10 Year Term Life Insurance Policy• Purchased 6 years ago

• Zeros Out C-Corporation Every Year

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What Jane Needs

• Additional Life Insurance Protection

• 10 year term doesn’t cover her needs• Loss of Jane’s income puts family in

financial jeopardy

• Supplemental Retirement Income• 401(k) profit sharing plan is not enough• Medical expenses could deteriorate Jane’s

retirement nest egg

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What Jane Would Like

• Current Income Tax deduction for Any Strategy Implemented

• Retire At Age 65

• No current successor in line

• Something Primarily for Her Benefit

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Possible Strategies

Section 79 Plans

Qualified Combo Plan

Non-Qualified Deferred

Compensation

Executive Bonus

419(e)Plans

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No clear succession plan for future of the business

Creditor risk? Not currently tax-

deductible

Already zeroing-out the C-Corporation

Does not reduce current taxable income

419(e)Plans

Section 79 Plans

Qualified Combo Plan

Non-Qualified Deferred

Compensation

Executive Bonus

Options Offthe Table

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* Please note that all of these strategies require the use of a qualified third-party administrator.

Section 79 Plans

Qualified Combo Plan

419(e)Plans

Viable OptionsRemaining*

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The Qualified Combo PlanMeeting the savings needs of business owners and employees

by combining the use of a Defined Benefit Plan with a 401(k) Profit-Sharing Plan

Defined Benefit Plan

401(k) Profit-Sharing Plan

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Qualified Combo Plan: The Business Owner’s Secret to Retirement Savings

Third Party Administrator (TPA) determines that Jane is a prime candidate for Qualified Combo PlanTPA cross-tests contributions to 401(k) profit-sharing plan on a benefits basis

The majority of her employees are at least 10 years youngerJane is already contributing to the profit-sharing plan

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Why The Qualified Combo Plan?

Jane can …Effectively limit the split-funded defined benefit plan for herselfAdd:

Up to $100,000 - $200,000 annually on a tax-deductible, tax-deferred basisLife insurance

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Internal Revenue Code Section 79

Tax rules regarding group term insuranceProvides requirements for either a master policy or individual policies to qualify as “group term life insurance”Allows corporation to establish group term plan that provides permanent benefits as well as group term benefits*

* Please consult with your employee benefits legal counsel as to whether this is an employee benefit plan under the Employee Retirement Income Security Act of 1974 (ERISA) and if so, whether any additional requirements are necessary to comply with ERISA.

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Permanent Benefit Section 79 PlanPremium payments are generallyfully deductible to the corporation*

Employees must pay taxes on the permanent cost of the policy as determined by the deemed death benefit formula**

Most employees don’t elect permanent benefits Employees also taxed on cost of death benefit protection in excess of $50,000

*Assuming it qualifies as an ordinary and necessary business expense under IRC Section 162.** Taxable income to participants in a Sec. 79 Permanent Benefit plan is comprised of two parts: (1) the life insurance benefit; and (2) the permanent benefit.

Calculation of taxable income is not performed by Pacific Life, and is not a part of any sales material or illustration prepared by Pacific Life. Taxable income calculations are typically performed by independent third party administrators based on their understanding of the Sec. 79 regulations. Pacific Life makes no representation as to the appropriateness of these taxable income calculations. You should obtain whatever advice you deem necessary and appropriate from your independent tax and legal counsel as to the reasonableness of those calculations performed by such third parties.

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Why a Permanent Benefit Section 79 Plan?Table I cost plus permanent benefit cost may be substantially less than the full premiumFirst $50,000 of death benefit may not result in any additional costDeath Benefit protection

Portable death benefitPost-retirement death benefit

Tax-free loans and withdrawals from the life insurance policy’s cash value for retirement income*

* Tax-free income assumes, among other things: (1) withdrawals do not exceed tax basis (generally, premiums paid less prior withdrawals); (2) policy remains in force until death; (3) withdrawals taken during the first 15 policy years do not occur at the time of, or during the two years prior to, any reduction in benefits; and (4) the policy does not become a modified endowment contract. See IRC Sections 7702(f)(7)(B), 7702A. Any policy withdrawals, loans and loan interest will reduce policy values and may reduce benefits.

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419(e) Plans

A welfare benefit planMust provide benefits other than retirement income

Benefits provided usually include:Pre-retirement death benefit protectionPost-retirement medical expense reimbursement

Post-retirement benefits must be offered on a non-discriminatory basis

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Adding Life Insurance To a 419(e) Plan

May be used to provide pre-retirement death benefit protectionMay be used as a sinking fund for post-retirement medical expenses

Many 419(e) plans use a taxable trustLife insurance cash value may provided tax-deferred growth

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Why a 419(e) Plan?

Provides pre-retirement death benefit protection on a pre-tax basis*

Does not provide retirement income, butMedical expenses are a pressing concern for many

Including long-term care419(e) plans can keep retirement savings from being diminished by medical expenses

* Please note that business is not permitted to take a deduction for contributions to the 419(e) plan to the extent those contributions pertain to current life insurance benefits.

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Working with Jane

All 3 strategies are viable optionsCould implement just one, or all 3

All 3 strategies provide:Life insurance death benefit protectionPotential retirement savings

419(e) plan by funding for potential medical expenses

Current income tax-deduction

It is up to Jane’s tax and legal advisors to determine which strategy is implemented

Section 79 Plans

Qualified Combo

Plan

419(e)Plans

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Case Study #2

• Mark House• Married with 3 children

• Net Worth: Over $30 Million

• Owner of House Trucking• Large intra-state trucking operation

• Split Into Multiple Entities (Creditor Protection)• 15 current entities• Mainly S-Corporations & LLCs

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What Mark Needs

•Additional Property and Casualty Insurance

• Current insurance policies do not cover all potential liability

• Gaps in coverage threaten future of business

• Estate Tax Liquidity*

• Largest asset is his business interests• Death after 2010 could subject estate to substantial estate taxes*

• May be forced to sell business interests at a discount*As of January 1, 2010, the federal estate tax is repealed until December 31, 2010. Also, over the same time period, the rules regarding step-up in basis for property

transferred at death were replaced with a modified carryover basis at death rule. Congress continues to consider legislation that, if passed, may change current federal estate tax law. Please consult with your tax and legal advisors as to what effect the repeal of federal estate taxes in 2010 and their reinstatement in 2011, or any new federal estate tax legislation, may have on your estate plans.

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What Mark Would Like

• Potential Control of Property and Casualty Insurance

• Reduced Gift-Tax Cost for Estate Tax Liquidity Need

• Current Income Tax-Deduction

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Captive Insurance Companies

A small property and casualty insurance company

Formed as a C-CorporationGenerally formed to provide coverage to a single parent

Must be at least 12 related partiesCoverage that is either

Not available through traditional property andcasualty insurance, orCoverage that the business would traditionally self-insure

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Captive Taxation

Contributions to the captive are tax-deductiblePremium income of less than $1.2 million is tax-free to the captive*

Must elect and qualify for 831(b) treatment every year

Growth inside of the captive is taxable at corporate tax rates

*IRC Section 831(b)

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Captive Insurance Companies & Estate PlanningCaptive can be used as a source of funds to provide estate tax liquidity

Generally done through a split dollar arrangement with an Irrevocable Life Insurance Trust (ILIT)

Economic benefit or loan regime

Captive pays the premiums and is collaterally assigned the cash value

ILIT will pay the Reportable Economic Benefit (REB) or loan interest to the captive

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Planning for Mark

Establish a captive to provide coverage for House Trucking

Captive could be owned by:MarkMark’s childrenILIT created by Mark

Create an ILIT to purchase the life insurance for estate liquidity

Could be single life or survivorship life insuranceDraft split dollar agreement between captiveand ILIT

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Captive Insurance Company

Diagram

HouseTrucking

LifeInsurance

Irrevocable Life Insurance

Trust (ILIT)

Property & Casualty Premiums

Collateral AssignmentPremiums

MarkHouse

REB

Death Benefit

Gifts

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Working with Mark

Captive insurance companiesExtremely complexRequire coordination of Mark’s

Tax and legal advisors Qualified TPA

If structured properly, captive insurance company may

Meet property, casualty and estate planning needsCreate a current income tax-deduction

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Deduct It!Resources

• Client Brochure• 419(e) Case Study• Captive Case Study • Client Profile• ADU Casts & ADU Ideas CD

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Investment and Insurance Products: Not a Deposit – Not FDIC Insured – Not Insured by any Federal Government Agency – No Bank Guarantee – May Lose Value

Pacific Life Insurance CompanyNewport Beach, CA

(800) 800-7681 • www.PacificLife.com

Pacific Life & Annuity CompanyNewport Beach, CA

(888) 595-6996 • www.PacificLifeandAnnuity.com

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This material is not intended to be used, nor can it be used by any taxpayer, for the purpose of avoiding U.S. federal, state or local tax penalties. This material is written to support the promotion or marketing of the transaction(s) or matter(s) addressed by this material. Pacific Life, their distributors and their respective representatives do not provide tax, accounting or legal advice. Any taxpayer should seek advice based on the

taxpayer’s particular circumstances from an independent tax advisor.

Pacific Life refers to Pacific Life Insurance Company, and its affiliates, including Pacific Life & Annuity Company. Insurance products are issued by Pacific Life Insurance Company in all states except New York, and in New York by Pacific Life & Annuity Company. Product availability and features

may vary by state. Each company is solely responsible for the financial obligations accruing under the products it issues, and its product and rider guarantees are back by that company's financial strength and claims-paying ability.

Pacific Life Insurance Company’s individual life insurance products are marketed exclusively through independent third party insurance professionals, which may include bank affiliated entities. Some selling entities, which may include bank affiliated entities, may limit availability of

some optional riders based on their client’s age and other factors.

Non-guaranteed elements are not guaranteed by definition. As such, Pacific Life reserves the right to change or modify any non-guaranteed element. This right to change non-guaranteed elements is not limited to a specific time or reason.