Got a yen for a REBA? No, I’m not speaking Spanish or about the popular country singer. I’m talking about a non-qualified executive benefit arrangement thats seeing a revival of interest among business clients: Restrictive Executive Bonus Arrangement (REBA).
Until recently the non-qualified executive benefit market has been dominated by non-qualified deferred compensation arrangements, stock option plans and equity split-dollar arrangements.
However, employers increasingly are asking financial service professionals for advice on alternative executive benefit arrangements. And thats where REBAs are gaining appeal.
Why is a REBA gaining interest among employers? Its due in part to the “baby boomer effect” as more people enter middle age and accelerate planning for their retirement. Many are frustrated by the contribution limitations imposed by qualified plans and so their attention has turned to non-qualified executive benefit arrangements using life insurance to protect their family and also for supplemental retirement income.
Second, a lot of folks are coming down with a bad case of the “willies” due to the uncertainties of the proposed income tax reduction package, shifting stock market and the Internal Revenue Notice 2001-10 on equity split-dollar arrangements.
The REBA has specific attractions for this market and outflanks some of the more traditional non-qualified executive benefit arrangements in key ways. It can provide benefits such as administrative simplicity, plan flexibility and portability. However, it is most notable as a way for an employer to gain a current income tax deduction while restricting the employees access to the life insurance policys cash values.
What is a REBA? Basically, it is a variation of a Section 162 bonus arrangement where the employee’s rights to the life insurance policy are restricted.
There are three tools to creating this arrangement. First, there is the 162 bonus arrangement where the employer bonuses the premium of a life insurance policy that is owned by the executive.
The second component is a separate employment contract with the employee.
Finally, there is the restrictive endorsement applied to the insurance contract at the time the policy is acquired from the carrier. The endorsement generally is designed to continue until a specific date or the bankruptcy of the business.
It is important to note that the endorsement does not give the employer an interest in the policy cash value or death benefit. In general, employee access to the policy is limited either by the restrictive endorsement itself or through a vesting schedule with right of reimbursement contained in the employment contract.
Financial professionals working with clients interested in establishing a REBA should be aware there is some controversy over the taxation of the arrangement, as well as potential ERISA application. In general, the tax controversy can be divided into two camps.
In one camp are those who believe the employer may receive an immediate income tax deduction for the premiums paid by the employer (and taxable to the employee) as long as it qualifies under Section 162 as an ordinary and necessary business expense and the compensation to the employee is considered reasonable. This group treats the arrangement as a transfer of premium.
It should be mentioned that Section 264 prohibits an employer from deducting premium when it is directly or indirectly a beneficiary of a policy. In this regard, Section 264 makes it clear that the term beneficiary is broader than a mere right to death proceeds, and appears to extend to the situation where an employer has an economic interest in the policy. It is for this reason that any cost recovery or forfeiture back to the employer associated with this life insurance policy may jeopardize the tax deductibility of the bonus.
In the other camp are those who believe that providing the employee with a restricted life insurance benefit is a transfer of restriction property under Section 83. This camp points out that under Section 83 the employee does not recognize income and the employer is not permitted a deduction until the risk of forfeiture or restriction lapses. This group notes that section 83 does permit an employee to treat the property as vested by making an 83(b) election. Where the employee makes an 83(b) election within 30 days of the transfer, the property is deductible to the employer and taxable to the employee.
Thus, using an annual 83(b) election the employer is able to receive the same immediate income tax deduction as held by proponents of 162, with the difference being the addition of annual 83(b) election administration. Bottom line, whether the employer is able to receive an immediate income tax deduction depends on the arrangements features.
Given the potential benefits of a REBA for both the employer and the employee, benefits such as current tax deductions make REBAs an appropriate arrangement to provide an executive benefit which otherwise may be difficult to provide at a reasonable cost.
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Reproduced from National Underwriter Life & Health/Financial Services Edition, June 11, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.