Many other traditional methods of providing non-qualified retirement savings or benefits to key employees have become increasingly complex to implement. The advent of the 409(A) regulations have put strict rules in place as to plan design, and created heavy penalties for the participants should the plan not meet those guidelines. www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00000409—A000-.html
Employers are wary of the potential for lawsuits should they fail to meet all the necessary guidelines of 409(A). In addition, in our current economic climate, executives are increasingly wary of tying their retirement funds to the financial viability, or legal liabilities, of their employer. A requirement of traditional nonqualified plans is that they are unfunded, and that any funds supporting the plan are subject to the general creditors of the employer. This can appear as a great risk to the employee.
Executive Bonus Plans are experiencing a renaissance: they provide a way for a key employee to purchase life insurance using employer dollars. Generally, the employer pays the premium and adds the bonus to the employee’s W2 income. Alternatively, the employer could bonus the employee cash and the employee would then use the after tax dollars to pay the premiums.
The life insurance can provide death benefit protection to the executive’s family, and it can also be funded to provide tax advantaged retirement income as well. As the life insurance is employee owned, the creditor risk of a traditional nonqualified plan is avoided. There are no required distributions at age 70 ½ as there are for IRAs or other qualified plans, and there are no penalties for removing funds from the life insurance policy prior to age 59 ½.
Executive Bonus Plans are very flexible. There are no participation requirements – the employer can fully discriminate as to whom the plan is offered. Incentives, such as sales goals or company profitability, can be built into the arrangement if desired. Restrictions can be placed on the plan, requiring repayment of some or all of the bonuses, if the key executive leaves prior to a designated amount of time.
So, how does it work?
- First the employer and executive agree that the bonus plan is an important part of his or her compensation package.
- The executive purchases a life insurance policy.
- The employer makes premium payments on the policy and the executive pays tax on the bonuses as ordinary income.
- The executive can receive income through withdrawals and loans from the insurance policy’s surrender values. [i] If the executive dies at or before retirement, income tax free death benefit proceeds are paid to his or her beneficiaries.[ii]
Where does the flexibility come in?
The actual bonus amount, whether it is a single bonus or a double bonus, any restrictions on the bonus, or promises of increases to the bonus, are all open to negotiation. If a single bonus is used, the employee can choose to either have the full amount put into the policy, or just the net amount after paying the appropriate taxes. If the employer desires, the employer can gross up the bonus, creating a “double bonus” which provides enough money to pay the taxes plus the premium dollars.
When it comes to the life insurance policy, the executive can purchase the contract that best meets his or her needs. While this will often be a policy for cash accumulation, in order to provide projected income at retirement, in some cases the executive will be more interested in the death benefit. Either option is open in this kind of plan.
Are there legal documents needed? The answer is “maybe”.
Some employers will want to put the plan into writing in order to avoid confusion as to the goals of the plan and exactly what is being promised.
Some employers will also want to put a restriction on the plan. These are commonly called Restricted Executive Bonus Arrangements (REBAs). Language is usually put into an employment agreement specifying how long the executive needs to stay with the firm and what will occur if the executive leaves early. In addition, some life insurance carriers have a form that can be used in conjunction with the agreement to limit the executive’s ownership rights. The limitation does not grant rights to the employer, but limits the executive’s rights to surrender the policy while the agreement is in place.
Some broker dealers will require evidence that there is an actual plan in place. This can often be satisfied by a Corporate Resolution. Many life insurance carriers can provide sample legal documents which can reduce the employer’s out of pocket expenses to implement the plan.
The Executive Bonus Plan is a classic design that provides protection for the family during the executive’s income producing years, and the ability to increase retirement savings as well. It is simple to implement and administer, and can be an excellent tool in retaining key employees.
Pamela Duncan, CLU, ChFC, is a senior executive benefit specialist with the Insurance Sales Support Team of ING Americas – U.S. Financial Services, Windsor, Conn.