Giving Scrutiny to Your Business Continuity Part 4

Here's the fourth of a four part series titled Giving Scrutiny to Your Business Continuity.

More Split Dollar Magic 

There is a corollary to our Split Dollar example. If neither partner dies prior to retirement, and if Partner A wished to buy Partner B's interest, the earnings within the permanent life insurance policy in excess of the premiums advanced are available to Partner A to use as a down payment for this purchase. 

Let's assume that both Partner A and Partner B choose to retire at the same time because the next generation is stepping into the picture. Whatever the reason, it requires termination of the Split Dollar arrangement. Here lies the real magic of Split Dollar. 

Partner A makes a withdrawal from his or her permanent life insurance policy equal to the premiums advanced over the previous years by the company. This withdrawal is tax-free because life insurance is the only financial tool that allows withdrawals under FIFO Accounting (First In, First Out). 

Partner A uses the money to repay the company for its premium advances, thus terminating the Collateral Assignment. The balance of the money, Partner A's "split" of this permanent policy, is likely to be substantial after a number of years. This represents a personal tax-deferred cash asset that Partner A can use to supplement retirement income needs. 

Salary Continuation—Frosting on the Cake 

Finally, we should explore one additional concept briefly. At exactly the time Partner A was retiring from the company, as explained above, he or she wrote a check to the company in repayment of premium advances made over the years. A selective Salary Continuation (Diagram F) plan would cover that check. The intent of the Salary Continuation plan is to assure that each insured partner personally recovers money equal to the premium advances made on the Split Dollar policy he or she repaid to Aggressive, Inc. 

Your advisory team should suggest drafting a Salary Continuation agreement concurrent with the Cross-Purchase and Split Dollar agreements. The basic provisions of this agreement are for Aggressive, Inc. to pay a supplemental income to Partner A at some future date, and to pay a supplemental income to Partner A's estate at some future date-in case Partner A dies before retirement. Note that no current income tax liability is created for Partner A by the promise of these future benefits. 

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DIAGRAM F

Executive Salary Continuation

Basic Agreement Provisions:

1. To pay supplemental income to Partner A at some future date.
2. No current tax liability to Partner A for future benefits. 
3. To pay a supplemental income to Partner A's estate at some future date in the event of his death. 
4. Intent is to assure recovery of the premium portion of the life insurance policy to Partner A or his estate after split-dollar "Roll-out." 

In the Event of Partner A’s Death:‍

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At Retirement of Partner A:

Although the illustration is simplified to cover only Partner A, the same opportunity would likely be installed for all partners having significant ownership. 

The funding for the plan occurs when needed—at retirement. Remember, the partners withdrew money from their permanent life insurance policies and repaid Aggressive, Inc. for the premium advances made on their behalf. Now each will begin to receive "salary continuation payments" for a time specified in the Salary Continuation plan drafted many years earlier. 

Summary 

Our discussion up to now has focused on concepts-specifically business continuity, split dollar, and salary continuation. These concepts, once explored and understood, can be woven together to provide the business owner a tapestry of the most efficient use of resources. 

Regardless of what legal contract you use, it's absolutely necessary that business people wanting to create wealth install a Business Continuation Agreement that includes an annually updated valuation.