Small business owners have numerous needs: business succession planning; personal retirement planning; providing retirement benefits to employees; and retaining key talent in a competitive job market. One option for fulfilling these requirements is the executive bonus plan using a life insurance policy.

Consider Mary and Edward, a married couple and successful entrepreneurs, who started a small business nearly 20 years ago. As they enter their 50s, they contemplate life after business and dream of retirement. They currently have five employees, one of whom is Joan, the prime candidate to run the business following their retirement.

Mary and Edward have come for advice on what to do with their business, their employees and their retirement. Lets examine their concerns.

Mary and Edwards Retirement

Like many business owners, Mary and Edward have spent so much effort growing their business that they have not planned for their life together after the business. They hope to retire within 10 years. The money to fund their retirement plan is of little concern as their business makes plenty.

They are simply looking for a vehicle that can provide an adequate retirement income. Of course, they would like to have the benefit of tax-deferred growth potential and pre-tax contributions. However, they understand that with retirement so close, they need to fund a plan quickly and with large sums of money.

While contributions to an executive bonus plan are made on an after-tax basis, the growth within the policy, if there is any, is not taxable. Also, a cash value life insurance product can provide tax-free retirement income by way of policy withdrawals and loans.

Mary and Edwards primary goal is retirement income. Since they are both over 50 years old, for 2005 they each can make a maximum IRA contribution of $4,500. An executive bonus plan, using a life insurance policy, does not have the same contribution limits as an IRA.

Although the modified endowment contract rules apply to withdrawals during life, legally there is no maximum amount the client can place into the life insurance policy. However, the life insurer may impose some limitations relative to the size of the policy issued and the health of the insured.

Because the premium payments are made with after-tax dollars, and any withdrawal up to basis is not taxable, an executive bonus plan begins to resemble a Roth IRA. However, the executive bonus plan, which has charges and fees associated with the policy that include the cost of insurance, allows for potentially unlimited contributions. And there is no tax penalty for early withdrawals.

With the use of a variable product, the client may have investment choices that resemble those available in a Roth IRA that uses a variable annuity. Severe tax consequences exist if the policy lapses prior to death; precautions should be taken to ensure this does not happen.

Retaining Their Top Employees

While Mary and Edward appreciate all of their employees, some of them hold more valuable roles within the business. They would like to find a benefit for all their employees, but they want Joan to receive a better benefit than the others. And they want to receive a benefit superior to Joans.

The same executive bonus plan that can provide retirement income for them also can benefit their employees. The plan allows an employer to include as many or as few employees as it chooses. Furthermore, the amount of the bonus paid to each employee is at the discretion of the employer.

Many small business owners fear that after they have invested time and money in an employee, that person will leave their company. With an executive bonus plan, the employee owns the life insurance policy and may exercise all the benefits of such ownership.

To restrict free access, the business can establish a restricted executive bonus agreement. With a REBA, the employee is prevented from accessing the cash value of the policy, surrendering the policy or using the policy as collateral for a loan until the occurrence of a specific event.

Ownership does not change. Should the employee seek employment elsewhere he/she still owns the policy; however, the restriction is still in place. With most plans, the restriction is lifted after a predetermined number of years, upon attainment of a certain age, retirement or bankruptcy of the employer.

Of course, the employer is free to release the restriction at any other time it deems appropriate. If the employee leaves prematurely, not fulfilling the terms of the agreement, the employee may have to pay back premium paid by the employer.

Transferring the Business

As mentioned, Mary and Edward are beginning to imagine a life of retirement. After working so hard to build their business, they would hate to see it decline. Joan is their hardest working, most tenured employee and they hope she will take over. However, Mary and Edward do not want to gift the business to her. So, they inquire about an executive bonus plan. As their advisor, you tell them that they can use the funds from their life insurance policies for retirement income. And Joan can take withdrawals and loans against her policy to help fund an installment purchase of the business.

Thus, a single plan may address all of the concerns of your client. By instituting an executive bonus plan using life insurance, Mary and Edward can fund their retirement at a comfortable level.

Their employees have a benefit that provides retirement income. Joan has a vehicle for funding the purchase of their business. And all participants will leave a death benefit for their loved ones, assuming the policy is in force at their death.

Peter Radloff, JD, is vice president of advanced markets at Jackson National Life Distributors Inc. in Denver, Colo. He can be reached at peter.radloff@jnli.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, February 11, 2005. Copyright 2005 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.