Consider The Restricted Executive Bonus Arrangement
Have you ever run into this situation? A small business client wants to provide an exclusive benefit for a key employee but wants to be able to take an income-tax deduction now and keep control over the benefit. If youve worked in the small business market, youve undoubtedly heard this desire repeatedly expressed.
The answer to this problem has never been easy. A qualified plan offers an income tax deduction but cannot be offered in a discriminatory manner to just a single employee. A non-qualified plan can provide benefits for a single key employee, and gives the employer control over plan design and funding, but offers no income tax deduction until benefits are paid to the employee or his family.
There is another option that might appeal to small business owners wanting an income tax deduction while retaining some control over the employees benefit, the Restricted Executive Bonus Arrangement (REBA).
How It Works
In a REBA, the key employee owns a permanent life insurance policy on his or her life and will name a personal beneficiary. The employer will pay the premium and the employee will recognize the premium as additional compensation income. The employer may also provide the employee with a taxable bonus equal in amount to the income tax generated by the premium and the bonus. The premium and the bonus are income tax deductible for the employer as long as the employees overall compensation is reasonable.
So far it sounds like a standard executive bonus plan. What distinguishes a REBA from a standard bonus plan, however, is that with a REBA the employee and employer sign an endorsement that is placed on the policy–restricting the executives access to policy cash values.
This gives the employer the ability to have some control over the employees actions regarding the insurance policy. Typically, the endorsement restricts the employees ability to access policy cash values, transfer the policy, or surrender it. A separate plan document, signed by the employer and the employee, contains a schedule that provides when the employee will have full access and complete control of the policy. This might be after a number of years of future service, such as 10, or at the employees normal retirement age.
Why Use a REBA?
REBAs provide another incentive to the key employee to continue his or her employment with the company. Depending upon the employees personal situation, risk tolerance, and financial goals, a variable universal life policy might be the type of policy used in the REBA.
By avoiding Modified Endowment Contract status, once the employee has access, the policys cash value can be used through withdrawals and loans in a tax-favored manner to supplement retirement income or to draw upon in the case of an emergency. If the employee dies, either with or without access, his or her family would receive an income tax-free death benefit equal to the policy face amount.
The employer can take an income tax deduction for the premium and related bonus because it has no direct interest in the policy and is not a partial beneficiary of the life insurance death benefit.
A common question is, “What happens if the employee terminates employment before he or she has full access?”
It could be that nothing happens other than the employer stops paying the premiums. The former employee can still only access that portion of the cash value according to the access schedule and cannot surrender the policy. Assuming the employee continues to pay the premium, he or she will eventually vest under the schedule given in the REBA agreement. The continuing restriction on access to cash value alone may have an appeal to a business owner who may fear the former employee would use the policy cash values to start up a business to compete against the employer.
Most likely, the employer and employee will negotiate how to handle the restricted cash value access, but the schedule certainly gives the employer the upper hand in such negotiations. Can the employer require repayment of any amount? The plan document that governs the REBA can require repayment of the restricted amount. However, such a provision could jeopardize the employers income tax deduction.
Who Can Benefit from a REBA?
Small and medium-size employers who want to retain key employees without installing a qualified plan or want to offer an exclusive benefit as a supplement to an existing qualified plan can benefit from a REBA. Employers who want an immediate income tax deduction while retaining some control over the employees actions regarding the life insurance policy may find that a REBA enables them to maintain control of the policy while reaping the benefit of the deduction it affords them.
If youve been stumped by clients who ask, “How can I deduct it but keep control too?,” it may be time to contact them to determine if a REBA might allow them to provide an exclusive employee benefit, and get a deduction as well.
John A. Oliver, CLU, ChFC, is vice president, strategic marketing services, for Transamerica Insurance & Investment Group, Los Angeles, Calif. He can be reached via e-mail at John.Oliver
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.