These are difficult times in the executive benefit arena. The IRS has made significant changes to split-dollar plans. We have encountered and weathered the legislative attacks on executive benefit perquisites caused by the accounting scandals of some very large corporations.
The prospect of new legislation adversely impacting executive benefits has left many businesses hesitating in their choice of a plan. What plan will provide reasonable security and remain viable through these turbulent times?
Look no further than the tried and true: a Section 162 bonus plan. When I think of this plan, the words fancy, daring, provocative and aggressive do not come to mind. I think of simple, clean, lean, understandable and safe.
Why not talk with your prospects about a bonus plan? The concept works universally for partnerships, corporations (including S Corporations), limited liability companies and nonprofit organizations.
The plan is easy to understand, which makes it easy to explain. Administration is simple and straightforward. From a tax perspective, the company receives a tax deduction in the year it pays a bonus and the company can “gross up” the bonus so the executive has minimal or no out-of-pocket cost.
Recently, I worked with a growing company that wanted to implement a plan to attract new executive talent. The business owner also desired to reward current executives for their success and provide incentives to them to stay with the firm.
The client considered several plans, including a deferred compensation plan, a supplemental executive retirement plan (SERP) and an endorsement split-dollar plan. Each plan offers strengths, but the client selected the bonus plan for three reasons:
? Little concern about recovering plan costs;
?Strong desire for deducting the annual premium; and,
? Desired simplicity.
Here are the plan particulars: The corporation, domiciled in Massachusetts, is in a 35% tax bracket. Executive No. 1, age 41, is a male, nonsmoker preferred. Executive No. 2, age 36, is a female, nonsmoker preferred. Both executives earn more than $100,000 of income annually. The assumed retirement age is 55. For illustration purposes we assumed the executives have a marginal income tax bracket of 40%.
The client wanted to pay a “double bonus” that would be sufficient to cover the executives tax due on the bonus and provide $10,000 net after tax for the annual policy premium.
The product used is single life variable universal life insurance (VUL), using a 6% gross crediting rate (5.12% net of fund management fee). The corporation chose the VUL policy for four key reasons:
? Expectation of better long-term value with potential policy cash values;
? Ability to illustrate the policy at a conservative rate;
? The option of a fixed interest account among the investment choices; and,
? The wide variety of investment choices within the insurers portfolio.
The client liked the idea of letting executives control their investment in the VUL policy. The executives can choose to design an asset allocation that best meets their individual long-term goals and risk tolerance.
The client purposely requested the illustrations to be run at a conservative interest-crediting rate. The net crediting rate of 5.12% is less than the current UL interest-crediting rate of 5.5%.
The client was sensitive to overstating future benefits from the VUL policy. By using a reasonable crediting rate, the executives would not set overly high expectations for income at retirement.
Additional assumptions include illustrating the VUL product using an increasing death benefit option during the pre-retirement years and then switching to a level death benefit option at retirement. We illustrated the insurance two ways: (1) by solving for an annual income from the policy for 10 years beginning at retirement so the policy potentially would have $50,000 of cash value at age 100; and (2) showing the policy without loans or withdrawals. See chart for results.
There you have it. No fuss, no muss. Clean, neat and simple. Flashy? No. But the bonus plan concept can be very useful in todays economic, legislative and political environment where uncertainty and confusion are the norm.
It provides both death benefit protection and the opportunity for income during retirement years. If your client is looking for the “tried and true,” then start your search with a bonus plan.
One additional note: Had the client been concerned that a bonus plan is not putting the so-called “golden handcuffs” on the executives, we could have added a restrictive endorsement to the policy. The endorsement is a contractual provision the life insurer must honor that would prevent the executive from accessing the policy cash value for a specific number of years regardless of his/her employment status with the company.
John F. Harrison, ChFC, is advanced markets consultant at John Hancock Financial Services, Boston, Mass. He may be reached at firstname.lastname@example.org.
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.