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The Leveraged Benefit Plan Compared Even though new Equity Split Dollar Plans will soon go away, we thought you would like to review a comparison of the Leveraged Benefit Plan to an Equity Split Dollar Plan. The accompanying illustrations use identical source data -- $2,500,000 level face amount with five $100,000 premiums (issue age 45). The differences are as follows: Leveraged Benefit Plan: Employer offsets the executive's loan interest payments with a gross-up bonus. Equity Split Dollar Plan: Employer offsets employee's income tax on the plan's economic benefits with a gross-up bonus. The issues to consider with both plans are as follows:
Table 1 Leveraged Benefit Plan
*If the arrangement is rolled out. Table 2 Equity Split Dollar Plan
*If the arrangement is rolled out. As you can see by comparing Column (1) in Table 1 with Column (1) in Table 2, the cost to the employer is less during the early years with the Equity Split Dollar Plan. This is because the economic benefit of the Equity Split Dollar Plan is a little less than the loan interest associated with the Leveraged Benefit Plan. In later durations, the reverse is true -- significantly so. Interestingly, the employer's receivable, the executive's cash values, and the executive's death benefits are identical with either plan; however, a major advantage of the Leveraged Benefit Plan is the absence of any income tax due by the executive if the plan is rolled out, which, in the case of the Equity Split Dollar Plan, might have to occur -- due to its soaring economic benefit costs and the employer's cost of the bonus needed to reduce the executive's out-of-pocket cost to zero. An alternative would be to terminate the bonus and have the executive pay the income tax on the economic benefit -- a poor option indeed. For example, this would cost the executive $271,522 in income tax in year 40 (in our example, 40% of the 40th year Table 2001 cost of $678,805). The executive could use policy loans to pay the income tax; however, the increasing loans caused by the sharply increasing economic benefit would soon dig a huge hole in the policy cash values ultimately forcing a rollout with taxable income of the gross cash value of the policy. (Policy loans would not reduce the amount taxed at rollout.) Death would be the only clean way out. Note: For Equity Split Dollar Plans entered into during the remaining window for such plans (until final regulations are published later this year), Section 83(b) elections may avoid taxation at rollout. Other than the 83(b) technique, under the new rules, new Equity Split Dollar Plans have no possible way to avoid taxation at rollout. Note: IRS Notice 2002-8 offers relief from rollout taxation of Equity Split Dollar Plans entered into prior to January 28, 2002, provided the rollout occurs prior to January 1, 2004. If a seasoned life insurance policy subject to an Equity Split Dollar arrangement can be sustained after a rollout by that date, it would behoove the parties to roll it out. If it can't be sustained thereafter, it should be converted by that date to a Leveraged Benefit Plan. (Our Leveraged Benefit Plan module can illustrate the conversion of an in-force Equity Split Dollar Plan to a Leveraged Benefit Plan.) Note: According to IRS Notice 2002-8, after final regulations are published, new Equity Split Dollar Plans are effectively finished as the employer's entire premium share will represent ordinary income to the executive when it is advanced by the employer. Examine the numbers in the two Tables above. Our conclusion is that, even if the IRS were to leave Equity Split Dollar Plans alone, we are much better off with Leveraged Benefit Plans. That is good news! You can review the illustrations we used to prepare this article by clicking here for the Leveraged Benefit Plan, and here for the Equity Split Dollar Plan. (It is possible that some readers may find that some variation of an Equity Split Dollar Plan is still preferable. If so, let us pose this question: What are you going to use after final regulations are issued and Equity Split Dollar Plans go away? We intend to integrate several perspectives of both the Leveraged Benefit Plan and the Private Leveraged Benefit Plan (an alternative to Private Equity Split Dollar) into the current series of articles. Stay tuned. Revised: [6-5-02]
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