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 clients who are searching for a benefit tool to reward key executives and they need a tax-deductible contribution, then 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.
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.
The restricted executive bonus arrangement allows the employer to not only stay in control, but it also can provide a company with a current income tax deduction. Additional benefits include:
==An enhanced ability to recruit and retain key executives;
==Ease of implementation and maintenance;
==The ability to pick and choose participants; and,
==The ability to implement or terminate the arrangement without IRS approval;
Benefits for the employee include:
o Zero income tax where a double bonus is used;
o The ability to customize benefits and contributions;
o Tax-deferred growth of policy values;
o Access to policy values after release of the restrictive endorsement;
o Protection of individually owned policies from company creditors;
o Portability–the policy is not lost if the executive changes employers; and,
o Income tax-free death benefits for survivors under IRC 101(a) when life insurance is used.
For the bonus arrangement to provide the needed tax results and avoid 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.
The bonus arrangement includes three components: the employment contract, the bonus, and the restrictive endorsement.
Step One: The Employment Contract
The employer and executive agree to add personal life insurance protection or an annuity to the executive’s compensation package. Legal counsel modifies the current employment contract (or drafts a new one), wherein the employer agrees to pay premiums in exchange for the executive’s unsecured promise to continue to render services to the employer. Should the executive terminate employment, the contract provides that the employer recovers all or part of the company’s contributions.
Step Two: The Bonus
Payment of the annual premium is considered an I.R.C. ?162 bonus. The employer can therefore deduct the bonus as a regular and necessary business expense (subject to reasonable compensation rules). A single or double bonus plan may be used.
With respect to the first, the premium paid on the policy is treated as a bonus to the executive and is included in his or her taxable income. The double bonus is used when an employer chooses to bonus additional money to the executive to cover income and payroll taxes resulting from the payment of the insurance premiums. This results in zero tax 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 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.
Given the complexity caused by the most recent legislation to split-dollar and nonqualified deferral plans, your client may be interested in an alternative benefit arrangement for key executives. A restricted executive bonus arrangement can be a simple and straightforward alternative for employers who are looking to reward and retain key executives while providing a tax-deductible contribution.
Matthew Rowles is director of advanced marketing for the Field Sales Support Organization of Prudential Financial, Newark, N.J. You can be e-mail him at firstname.lastname@example.org.