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Financial Planning > Tax Planning

Benefits Planning: Mid-Level Executives Start Getting Attention

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Mid-Level Executives Start Getting Attention


Advisors and planners have long devoted energy and expertise to creating and supplementing the benefits of top-tier executives at corporations large and small. Whats new, however, is that this attention from planners is moving downstream to mid-level executives.

Providing executive benefits no longer only involves planning for the very top end executives and CEOs of companies, says Gary Rathbun, president of Private Wealth Consultants, Toledo, Ohio. “I think there is a lot of money floating around the middle management market.”

The market segment Rathbun has been targeting for executive benefit planning includes those individuals who are mid-level decision makers, earn a good income, and have decent net worth–most of which is in their qualified plan. “Theres a huge market there for mid-level executives and up.”

One planning technique for this group with which Rathbun has had some success is what he refers to as a Section 402 rollout. Under this strategy, he explains, someone who has worked for a public company and holds a great deal of employer stock in his pension plan can transfer that stock into a regular non-qualified brokerage account upon termination from the plan.

“You will only pay ordinary income tax and the 10% penalty on the cost basis of the stock,” he says. “The rest is long-term capital gains.”

Rathbun gives an example of a client who recently left her company with between $600,000 and $700,000 in her qualified plan positioned in employer stock. “The cost basis on that stock was only $39,000. She paid the income tax on that, and the 10% penalty. The rest was a long-term capital gain at 20%, and now the money is out of the plan,” he says.

Upon moving the employer stock into a non-qualified brokerage account, Rathbun notes that it is important to then diversify those funds.

Like other executive benefit programs, the Section 402 rollout strategy has been around for quite some time, says Rathbun.

An executive benefit planing strategy that continues to be popular is the executive bonus plan, also referred to as the Section 162 plan. Many planners feel this is the simplest executive benefit, and is a favorite for pass-through tax entities, such as partnerships, S-corporations, and LLCs, says Perry Smith, JD, LLM, with Baystate Financial Services, a New England Financial office in Boston, Mass.

“Most owners want to provide a benefit to their executives, but they want to get a tax deduction for it as well,” he says.

Smith explains, “Theres an old twist that continues to be useful in this plan called the restrictive endorsement agreement.”

This agreement acts in a way similar to a vesting schedule on the policy purchased under the plan, he says. “The contract restricts the executives access to the policy during the term of the agreement,” says Smith.

One executive benefit planning technique that has come under recent scrutiny by the IRS is the split dollar concept. The January release of Notice 2002-8 has given planners some interim guidance as the IRS continues to work on final regulations. But, even with final rules uncertain, most planners agree that a properly designed split dollar plan can be an excellent funding mechanism for a life insurance executive benefit.

“Many times split dollar is the best method, so long as the economic issues, the control issues, and the tax issues are addressed,” says Bill Gettings, a partner at Gettings Reed Financial Services, LLC, Lafayette, Ind.

Smith agrees. “Split dollar is, indeed, not dead,” he says.

Smith feels that collateral assignment split dollar will continue to be a useful tool, even after the new regulations are released.

“The collateral assignment has typically been viewed by many of us in the planning profession as an opportunity to shift equity growth in excess of the employers interest over to the executive,” he explains.

“I would foresee that the biggest change in the writing of the split dollar collateral assignment agreement would be that the employers interest in the policy will now read, the greater of the aggregate premiums or cash value, which had historically been the lesser of aggregate premiums paid or cash value,” Smith says.

For new split dollar arrangements, Gettings feels the worst-case scenario that may come out of the new regulations would be that some type of tax will be due on any gains received.

“I have never had a conversation with a prospective client where they didnt say, Thats reasonable,” adds Gettings.

With the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), planners saw a number of new opportunities arise in the qualified plan marketplace. Qualified plans have received a good deal of criticism in the past for placing limits on highly paid executives, preventing them from saving an appropriate amount to maintain their standard of living in retirement.

But now, most planners agree that with the new rules on contribution limits and benefit amounts under EGTRRA, executives can set much more money aside for retirement.

“I think weve gone full circle,” says John Sight, an agent in New England Financials Kansas City agency.

“If you look at the tax laws from the inception of ERISA until now, they got much more complicated and difficult to understand,” he explains.

“Congress finally realized how complicated things were and how detrimental what theyve been doing is towards retirement planning, so they simplified it.

“I think the most exciting change in the law takes us back to an old friend of ours, the defined benefit plan,” Sight says.

He notes that the changes have effectively given the small business owner executive the opportunity to increase contribution levels well above the $40,000 limit.

“With the post-war Baby Boomers who havent done a good job with their retirement planning, this is an excellent opportunity for them to accelerate their funding,” he says.

Sight adds that it had been 8 or 9 years since he wrote a defined benefit plan, but he has now installed 3 plans in the last 6 months.

More opportunities exist with age weighted and cross-tested plans, adds Gettings.

“I think in the qualified world, weve never had a better environment,” he says.

“We take a good hard look at cross-tested or age-weighted plans, depending on the makeup of the company,” he says.

Gettings notes that about 90% of the plans he is installing are age-weighted or cross-tested. “We want to absolutely make certain that the rank-and-file have an appropriate benefit, but at the same time we dont want to discriminate in reverse against the highly compensated,” he says.

Reproduced from National Underwriter Life & Health/Financial Services Edition, June 24, 2002. Copyright 2002 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.


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