Fixed index universal life insurance (R-2/205) Allianz Life Insurance Company of North America Nonqualified deferred compensation plans A cost-effective way to reward and retain employees Fixed index universal life insurance CAN HELP FUND AN NQDC PLAN. A nonqualified deferred compensation plan (NQDC) allows your employees to set aside money or benefits that they can access later, under the conditions specified by the plan. These plans can be an effective employee retention tool if a vesting schedule applies because employees will be required to wait for the specified time period to realize the payment and/or benefit offered by the plan. When properly structured, nonqualified benefit plans allow employees to defer income taxation until the benefits are paid. Consider using life insurance to informally fund the obligations of an unfunded NQDC plan. An NQDC plan can be funded or unfunded. A funded plan can be more complicated to set up than an unfunded plan. There are many ways to pay for the obligations of a nonqualified deferred compensation plan. Fixed index universal life insurance (FIUL) can give additional death benefit protection, which can help beneficiaries address financial concerns such as income replacement, final expenses, estate taxes, and debt repayment. FIUL may also be a good choice for your business to informally fund your nonqualified deferred compensation plan, depending on your situation. As the employer, you begin by determining what type of NQDC plan to adopt. There are various NQDC plan types. To help pay promised benefits under the plan, you may decide to purchase a cash value life insurance policy on the employee. The employer owns the policy, pays the premium on the policy, and is the beneficiary of the policy. Over time, the policy s potential cash value accumulation may provide a source to pay for the NQDC plan s retirement benefit. When the employee reaches retirement age, the employer accesses any available cash value through policy loans and pays agreed-upon benefits to the employee. If the employee dies after the policy loans have started, the employer pays the employee s beneficiaries any remaining death benefit as required by the nonqualified plan. If the employee dies before retirement benefits begin, the employer (as the policy beneficiary) would receive an income-tax-free death benefit. The employer would then pay the employee s beneficiaries a survivor benefit equal to the amount deferred in the employee s plan. The employer would then retain any remaining death benefit. This value will vary by the amount of the death benefit minus any loans already taken. Keep in mind that any benefits paid to the employee (or the employee s beneficiaries) are fully taxable to them as ordinary income and are subject to payroll taxes. In addition, since life insurance is an underwritten product, any strategy that includes it is contingent on health underwriting and financial underwriting. Must be accompanied by the Understanding fixed index universal life insurance brochure (M-3959) or the appropriate product brochure. Policy loans and withdrawals will reduce available cash values and death benefits, and may cause the policy to lapse or affect any guarantees against lapse. Additional premium payments may be required to keep the policy in force. In event of a lapse, outstanding policy loans in excess of unrecovered cost basis will be subject to ordinary income tax. Tax laws are subject to change. You should consult a tax professional. Product and feature availability may vary by state. M-57 Page of 6
NQDC plans OFFER TAX BENEFITS to you and your employees. NQDC plans are FLEXIBLE AND OFFER VALUABLE BENEFITS. NQDC plans offer tax benefits for you and your employees, but to realize these benefits, your plan document, way of funding, and reporting must comply with IRS regulations and comply with the applicable IRS rules. Talk to your tax advisor or attorney before you set up a nonqualified deferred compensation plan. Benefits of nonqualified deferred compensation plans They give you flexibility. With nonqualified deferred compensation plans, you can design a plan that helps meet each employee s specific needs. That enables you to offer a more attractive plan to each employee who is most critical to your business while giving you control over the benefits themselves. They re a valuable benefit. Nonqualified deferred compensation plans can offer necessary life insurance coverage for your key employee(s). This FIUL insurance can become a part of your employees overall financial strategy. They can reduce employees annual income tax liability. As long as they re participating in a nonqualified deferred compensation plan, employees won t pay taxes on any income they defer, until they withdraw it from the plan. They help high-performing employees feel appreciated. This, in turn, may encourage your employees to stay with your company longer because the longer they contribute to the plan, the greater their benefit pool. They re cost-effective. Once they re set up, nonqualified deferred compensation plans are relatively easy to administer and maintain. Any costs associated with the maintenance of these plans is generally tax-deductible for your business, as are any benefit payments you make to employees. Keep in mind that, as the business owner, you can also set up and enjoy the benefits of a nonqualified deferred compensation plan for yourself if you are a C corporation. Special considerations of NQDC plans Notice and consent requirements for employerowned life insurance that all parties will need to review and sign. Any financial vehicle used to fund plan obligations is subject to company creditors. NQDC plans may be offered only to a select group of employees of C corporations and S corporations. The business can contribute to the plan, if desired, whether or not the employee actually defers salary to the plan. All parties should consult with their attorney and tax advisor to discuss their NQDC plan situation. Page 2 of 6
Hypothetical example of an NQDC plan using life insurance Gary works for Synergy Corporation (Synergy). He makes $300,000 per year and is looking for life insurance protection for his family. Synergy gives Gary the option of participating in a nonqualified deferred compensation plan. Gary elects to defer 0% of his annual income, or $30,000. Using Gary s deferred income, Synergy purchases a fixed index universal life insurance policy and pays $30,000 into the policy each year for 20 years. How life insurance can be used to informally fund the obligations of an NQDC plan NQDC plans are complex financial techniques, but they can be relatively simple to set up. Step. Gary and Synergy work with an attorney to create a benefit structure (e.g., how much income will be deferred, whether Synergy will contribute money, how it will be invested, when Gary can collect it, how it will be paid out, etc.). If Synergy offers a survivor benefit through the NQDC plan, they will also discuss the policy s death benefit. Synergy may consider attaching a vesting schedule to the benefit structure, as an extra incentive for Gary to stay with the company. The specifics of this benefit structure are drafted into a binding legal document. The parties will work with their respective tax advisor or attorney to ensure that the plan document conforms with Internal Revenue Code section 409A requirements. Step 2. Gary defers part of his compensation on a pre-tax basis. Synergy pools the money to fund the promised benefits. If life insurance is used, policy loans may be available to fulfill the obligation to Gary. This hypothetical example is provided for illustrative purposes only. The character is fictional and not an actual Allianz client. Policy loans and withdrawals will reduce available cash values and death benefits, and may cause the policy to lapse or affect any guarantees against lapse. Additional premium payments may be required to keep the policy in force. In the event of a lapse, outstanding policy loans in excess of unrecovered cost basis will be subject to ordinary income tax. Policy loans are not usually subject to income tax unless the policy is classified as a modified endowment contract (MEC) under IRC Section 7702A. However, withdrawals or partial surrenders from a non-mec policy are subject to income tax to the extent that the amount distributed exceeds the owner s cost basis in the policy. Loans, withdrawals, or partial surrenders from a MEC policy are subject to income tax to the extent of any gains in the policy, and if the payment occurs prior to age 59½, a 0% federal additional tax may apply. This publication is designed to provide general information on the subjects covered. It is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Allianz Life Insurance Company of North America, its affiliated companies, and their representatives and employees do not give legal or tax advice. You are encouraged to consult your tax advisor or attorney. An employer-owned life insurance policy may be subject to the requirements of Internal Revenue Code 0(j) in order to obtain an income-tax-free death benefit. In general those rules require that before the policy is issued, the employer must provide the insured with a written notice of the life insurance and obtain a written consent from the insured. Consult with an attorney for application of those rules to a specific situation. For more information on the tax implications of contributions to or distributions from this or any other employee benefit plan, you should consult your attorney or tax advisor. Page 3 of 6
Retirement BENEFITS EMPLOYER GARY Pays POLICY PREMIUMS Pays DEATH BENEFIT AGREE TO BENEFIT STRUCTURE INSURANCE COMPANY Death benefit to GARY S BENEFICIARIES (Loans from the policy are usually received income-taxfree by the business, but may be subject to the corporate Alternative Minimum Tax for a C corporation. Keep in mind that policy loans may not be available due to poor policy performance.) Step 3. When allowed by the plan, the funds or benefits are disbursed to Gary or his beneficiary(ies). These payments are usually tax-deductible for businesses and become taxable income to the recipient in this case, Gary. Policy loans and withdrawals will reduce available cash values and death benefits, and may cause the policy to lapse or affect any guarantees against lapse. Additional premium payments may be required to keep the policy in force. In the event of a lapse, outstanding policy loans in excess of unrecovered cost basis will be subject to ordinary income tax. Policy loans are not usually subject to income tax unless the policy is classified as a modified endowment contract (MEC) under IRC Section 7702A. However, withdrawals or partial surrenders from a non- MEC policy are subject to income tax to the extent that the amount distributed exceeds the owner s cost basis in the policy. Loans, withdrawals, or partial surrenders from a MEC policy are subject to income tax to the extent of any gains in the policy, and if the payment occurs prior to age 59½, a 0% federal additional tax may apply. Page 4 of 6
The result In this NQDC plan, Synergy is the owner and beneficiary of Gary s life insurance policy, and pays the premium using Gary s deferred compensation. If Gary were to die prior to retirement: Synergy would receive an income-tax-free death benefit Gary s plan beneficiary would be paid a survivor benefit equal to the amount deferred in Gary s plan (fully included in taxable income) Synergy would retain any remaining death benefit If Gary were to reach retirement age, Synergy would access the policy s available cash value through policy loans and pay Gary the amount promised for his retirement. Talk to your financial professional and request a personalized illustration showing how a nonqualified deferred compensation plan with obligations funded by life insurance can help be a solution for your business. Policy loans and withdrawals will reduce available cash values and death benefits, and may cause the policy to lapse or affect any guarantees against lapse. Additional premium payments may be required to keep the policy in force. In the event of a lapse, outstanding policy loans in excess of unrecovered cost basis will be subject to ordinary income tax. Policy loans are not usually subject to income tax unless the policy is classified as a modified endowment contract (MEC) under IRC Section 7702A. However, withdrawals or partial surrenders from a non- MEC policy are subject to income tax to the extent that the amount distributed exceeds the owner s cost basis in the policy. Loans, withdrawals, or partial surrenders from a MEC policy are subject to income tax to the extent of any gains in the policy, and if the payment occurs prior to age 59½, a 0% federal additional tax may apply. Page 5 of 6
True to our promises so you can be true to yours. A leading provider of annuities and life insurance, Allianz Life Insurance Company of North America (Allianz) bases each decision on a philosophy of being true: True to our strength as an important part of a leading global financial organization. True to our passion for making wise investment decisions. And true to the people we serve, each and every day. Through a line of innovative products and a network of trusted financial professionals, and with over 2.6 million contracts issued, Allianz helps people as they seek to achieve their financial and retirement goals. Founded in 896, Allianz is proud to play a vital role in the success of our global parent, Allianz SE, one of the world s largest financial services companies. While we pride ourselves on our financial strength, we re made of much more than our balance sheet. We believe in making a difference with our clients by being true to our commitments and keeping our promises. People rely on Allianz today and count on us for tomorrow when they need us most. Guarantees are backed solely by the financial strength and claims-paying ability of Allianz Life Insurance Company of North America. Product and feature availability may vary by state and broker/dealer. www.allianzlife.com Products are issued by: Allianz Life Insurance Company of North America PO Box 59060 Minneapolis, MN 55459-0060 800.950.962 Page 6 of 6