Restricted Executive Bonus Arrangements Provide Ample Rewards

By Matthew L. Rowles, CLU, ChFC, Advanced Marketing Director with Prudential’s Field Sales Support Organization

Running a successful business in today’s world is not an easy task. It takes the commitment of a talented team of knowledgeable executives. Their expertise is an invaluable asset that a business owner can’t afford to lose. Recruiting and retaining these executives requires more than just a good salary – it demands a competitive benefits package. If you have a client that is searching for a benefit tool to reward key executives and he/she needs a tax-deductible contribution –consider a Restricted Executive Bonus Arrangement.

Government regulations have made it difficult for employers to provide additional benefits to select employees using qualified plans. A qualified plan must cover a broad group of employees == not just key employees. Other alternatives – such as nonqualified deferred compensation and split dollar plans can be used, but unlike qualified plans these arrangements deny the employer a current tax deduction.

The Restricted Executive Bonus Arrangement combines an executive bonus with a restrictive endorsement on an insurance policy issued on the executive’s life. The restrictive endorsement acts as “golden handcuffs” encouraging the executive to remain with the company. Not only does the Restricted Executive Bonus Arrangement allow the employer to stay in control. But structured properly it can provide a company with a current income tax deduction.

For the employer, the benefits of a restricted executive bonus arrangement include:

?A benefit enhancement to recruit and retain key executives

?A current income tax deduction

?The company remains in control

?It’s simple and straight forward to implement and maintain

?Allows the employer to pick and choose participants

?No IRS approval needed for implementation or termination

Benefits for the employee include:

?Zero income tax cost where a double bonus is used

?Designed to meet individual benefit and contribution needs

?Values grow tax-deferred in the policy

?After the restrictive endorsement has been released, value can be accessed for personal needs

?Your individually owned policy is safe from company creditors

?Portability – the policy is not lost if you change employers

?When life insurance is used, the survivors receive generally income tax-free death benefits under IRC 101(a).

Note: For a Restricted Executive Bonus Arrangement to provide the needed tax results and to

avoid some or all the application of Title I of ERISA, it must be implemented and structured carefully. Consult a tax or legal advisor for advice regarding a particular situation.

[Graphic 1]There are three

basic set up steps to how a restricted executive bonus arrangement works:

>[Graphic 2]

Step One–The Employment Contract.

The employer and executive agree that personal life insurance protection or an annuity should be added to the executive’s compensation package. Legal counsel modifies the current employment contract (or a new contract is drafted) where the employer agrees to pay premiums in exchange for the executive’s unsecured promise to continue to make his or her services available to the employer. Should the executive terminate employment, the contract generally provides that the employer recovers all or part of the company’s contributions. The employer’s right to recover any contributions is grounded solely in the employment contract.

Step Two–The Bonus.

Payment of the annual premium is considered an I.R.C. ?162 bonus and it is generally deductible as a regular and necessary business expense by the employer (subject to reasonable compensation rules).

A single or a double bonus plan may be used.

Single Bonus. The premium paid on the policy is treated as a bonus to the executive and is included in his or her taxable income.

Double Bonus. This approach is used when an employer chooses to bonus additional money to the executive to cover the income and payroll taxes resulting from the payment of the insurance premiums. This results in zero tax cost to the executive.

Step Three–The Restrictive Endorsement.

In conjunction with the purchase of the policy, a restrictive endorsement is placed on the contract. This endorsement states that the executive cannot exercise any ownership rights in the policy other than naming or changing the beneficiary without the consent of the employer.

If the executive remains with the employer until the employment contract is fulfilled, the restrictive endorsement is released and the executive has unrestricted ownership of the policy. The value in the policy is now available for personal or family needs.

With the complexity caused by the most recent legislation to split dollar arrangements and nonqualified deferral plans your client may be interested in an alternative benefit arrangement for their key executives. A Restricted Executive Bonus Arrangement can be a simple and straight forward alternative for employers who are looking to reward and retain key executives while providing a tax-deductible contribution.

1 Life insurance policy cash values are accessed through withdrawals and loans. Loans are at interest. Unpaid loans and withdrawals cause a reduction in cash values and death benefits. In general, loans are not taxable, but withdrawals are taxable to the extent they exceed basis in the contract. Loans outstanding at policy lapse or surrender prior to the death of the insured will cause immediate taxation to the extent of gain in the contract. For polices which are Modified Endowment Contracts, distributions (including loans) are taxable to the extent of income in the contract, and an additional 10% federal income tax penalty may apply.

Insurance is issued by The Prudential Insurance Company of America, Newark, NJ, and its affiliates. [For Florida add: Life insurance policies contain exclusions, limitations, reductions of benefits and terms for keeping them in force. For complete details, see your licensed sales professional.]

Prudential, its affiliates and representatives do not render tax or legal advice. Please consult with your legal and tax advisors regarding your personal circumstances.

IFS-A0104706, Ed. 5/2005