It is possible to fund non-qualified deferred compensation plans with life insurance. A non-qualified deferred compensation plan is a binding contract between an employer and an employee. The employer makes an unsecured promise to pay an employee's future benefits, subject to the specific terms of the contract.
Funding Nonqualified Deferred Compensation Plans
Non-qualified deferred compensation plans are unfunded plans that are broken into two parts. The first part is the plan itself, which is equivalent to the contractual agreement between the employer and employee. The second part is the employer's general asset reserve that finances the future liabilities created by the plan. The general asset reserve is what the employer uses to pay the employee for the future benefits.
The general asset reserve is required by generally accepted accounting principles (GAAP) and can be taxable assets such as mutual funds or employer-owned life insurance. The plan is the legal benefit between the plan participant (the employee), and the plan sponsor (the employer). The plan outlines the overall benefits, distribution schedule, and vesting and forfeiture stipulations.
Types of Plans That Allow Life Insurance Funding
The two main types of non-qualified deferred compensation plans that allow life insurance funding are supplemental executive retirement plans (SERPs) and corporate-owned life insurance. SERPs are similar to defined-benefit pension plans and give an employee a stated benefit from the employer at the time of retirement.
With corporate-owned life insurance (COLI), companies purchase life insurance policies on employees they wish to compensate. The company pays the premium on the life insurance policies and then pays out benefits to the employees when they retire.
(For related reading, see "How Non-Qualified Deferred Compensation Plans Work.")