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.