With today's low unemployment rate and fierce competition in the market place, employers need ways to retain valuable executives.
Today most compensation and fringe benefit packages typically do not provide sufficient benefits to adequately compensate highly valued employees. Traditional or "qualified" retirement programs tend to discriminate against highly compensated key executives and other key players in an organization.
Hence, companies are left with a dilemma:
"How to design a retirement plan that benefits
both the company and the key decision-makers?"
A Possible Solution:
Non-Qualified Executive Benefit Plans. These plans can be an important cornerstone in providing a complete compensation package for key personnel in privately held, as well as in publicly traded companies.
These plans, sometimes known as "Golden Handcuffs", afford a company the opportunity to design a flexible, tax-deferred, cost-efficient compensation arrangement that aids in the recruitment and retention of valuable executives, while also minimizing the effects of reverse discrimination.
Listed below are four popular types of Executive Benefit Plans:
Split Dollar | Deferred Compensation | 162 Executive Bonus | Reverse Split Dollar
Split Dollar
Under a Split Dollar plan, a key employee receives a permanent life insurance policy at a reduced cost, gaining financial security for his or her survivors. At the same time, your business benefits by offering an attractive fringe benefit that helps recruit and retain key employees.
In a split dollar plan, you and your key employees agree to share the rights and premium payments of a permanent, cash value life insurance policy. The premium can be split in many different ways --as can the cash values and death benefits. If the employee dies or terminates employment, the employer is entitled to receive an amount equal to the premiums that were paid by the employer. When the agreement is terminated, the employee remains owner of the policy and controls all policy values.
Split-dollar life insurance may be structured in several ways. The two primary arrangements are:
Collateral Assignment -- The employee owns the policy and names a personal beneficiary but assigns a portion of the policy to the employer as collateral for the employer's premium advances.
Endorsement Method -- The employer owns the policy and an endorsement to the policy spells out the employee's rights.
Benefits of Split Dollar:
- Allows an employer to provide valuable life insurance protection for key executives on a selective basis
- Low-cost insurance protection for key employees to meet financial and estate planning needs
- The employer may recover the entire premium contribution to the plan
- Policy cash value accumulations in excess of the employer's cumulative premium payments may be available to the executive to supplement retirement income
Deferred Compensation
A Deferred Compensation plan is a contractual agreement between the employee and the employer whereby the employer promises to pay future income benefits to the employee for services yet to be rendered. The plan must be established under a "C" corporation arrangement.
As with most Executive Benefit Plans, a life insurance policy serves as the funding vehicle. The premiums which fund the policy come from the corporation and are not tax deductible to the corporation, nor are they taxable to the key employee.
However, when the deferred compensation is distributed, it then becomes tax deductible to the corporation and reportable as income to the executive.
During the agreement, the corporation retains all rights of ownership over the policy and names itself as the beneficiary. Over time, the policy builds tax-deferred value and a tax-free insurance benefit. Eventually, this tax-deferred build up will serve as the source for the deferred income proceeds.
Key Advantages:
- Deferred Compensation plans are not subject to discrimination or IRA approval
- The plan is easy to establish and maintain
- The employee is building retirement income assets free from current taxation
Section 162 Option
Under this type of agreement, the employee purchases a cash value insurance policy and names himself as owner. This policy may be issued on a single insured basis or a joint insured basis.
The employer pays the premiums to the insurance company, which is fully tax-deductible by the employer and considered compensation to the employee. The premiums are considered taxable income to the employee, so often times the corporation will 'double bonus' the employee.
Benefits to the Employer:
- Bonuses are tax-deductible
- The employer has discretion in the selection of highly compensated participants
- No maximum or minimum contribution requirements
- No IRS approval required
- Administrative expenses are nominal
- Plan may be terminated at anytime, pursuant to the agreement
- Plan design is simple and straightforward
- Golden handcuffs are created when using a restricted bonus arrangement
Benefits to the Employee:
- The employee owns the plan
- The plan can be designed to meet personal needs
- The employee's income tax costs can be covered by an additional bonus
- Tax-free income can be received from the plan via withdrawals and loans
- The employee has control over the plan, including beneficiary selection and asset allocation
Reverse Split Dollar
Reverse Split Dollar is very much like the Split Dollar Plan, except under this arrangement, the employer owns all or part of the "at-risk" element of an insurance policy, with the employee owning the cash value. The "at-risk" element is the difference between the cash value of the policy and the total death benefit.
The main objective of this policy is to provide a tax-free retirement benefits to the key person/owner/shareholder.
Benefits to the Employer:
- Employer has complete discretion in selection of participants
- No maximum or minimum contribution requirements
- Plan agreement does not require IRS approval
- Plan design is completely flexible in order to meet individual needs
- Administrative expenses are nominal
- Plan contributions and benefits may vary among participants
- The plan may be terminated at anytime, pursuant to agreement
- It assists in attracting and retaining key employees
Benefits to the Employee:
- Corporate dollars can be used to provide supplemental retirement benefits
- The plan can be custom designed to meet personal needs
- The employee's income tax costs can be covered by a bonus from the employer
- Cash values accumulate in a tax deferred manner
- Tax-free income can be received via withdrawals and loans
- Death benefits can be excluded from the employee's estate
- Death benefit proceeds are 100% tax-free
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