Transition Related, Financial Planning and Risk Management Terms, Definitions and FAQs

Apr 02, 2018
  • Deferred Compensation: An arrangement in which a portion of an employee's income is paid out at a later date after which the income was earned. Examples of deferred compensation include pensions, retirement plans, and employee stock options. This arrangement can be used to fund the transfer of a business from one generational to the next, possibly creating an tax savings for the exiting generation. 


  • Partnership Insurance: Insurance purchased by a partnership. Most often, this insurance is purchased to aid the business in continuing to operate in case of the death or disablement of one partner. There are two plans most often used in partnership insurance. Under a cross purchase plan, each of the partners purchases life insurance on the other, with themselves listed as the beneficiary. If one partner dies, the surviving partner uses the payout of the life insurance to purchase the deceased partner’s interest in the company. This type of the plan works best for a company with only two partners, while an entity plan works better for a team with multiple partners. Under an entity plan, the partnership purchased the life insurance policies on each partner, and is the beneficiary on each policy. Should one partner die, the partnership uses the insurance payout to buy the deceased person’s interest.


  • “Stay” or “Retention” Compensation Insurance: The retention bonus can be informally funded by the business through a permanent life insurance policy on the business owner’s life. The company is the owner and beneficiary of the policy. Upon the owner’s death, the death benefit may be used for various business purposes including paying the retention bonus. Upon an owner’s retirement, disability, or other lifetime departure, the cash values of the permanent policy can be used to pay the bonus. The business may also use the cash values of a permanent life insurance policy on the life of the key employee to pay the retention bonus. A business may choose to use a key employee policy to: (1) informally fund a non-qualified deferred compensation agreement; (2) help cover expenses and/or lost revenue upon a key employee’s death; and (3) informally fund a retention bonus.


  • GRAT: A grantor-retained annuity trust (commonly referred to by the acronym GRAT), is a financial instrument commonly used in the United States to make large financial gifts to family members without paying a U.S. gift tax.


  • Key Person Insurance: Life insurance on the key person in a business. In a small business, this is usually the owner, the founders or perhaps a key employee or two. These are the people who are crucial to a business--the ones whose absence would sink the company. Here's how key man insurance works: A company purchases a life insurance policy on the key employee, pays the premiums and is the beneficiary of the policy. If that person unexpectedly dies, the company receives the insurance payoff.


  • Split-Dollar: A mechanism for owning and paying for life insurance that can provide considerable flexibility when planning for closely held businesses. Split-dollar arrangements can be used for a variety of business related purposes that can aid in succession planning for closely held businesses. For example, split-dollar can be used: As a means of providing compensation to a key employee. In the context of planning for the succession of a closely held business this can be used as a financial incentive to entice a key employee to continue to perform after the demise of the business founder. To fund certain buyout arrangements, or for estate and succession planning purposes for the business owner.

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