Using Restricted Eec Bonus Arrangements

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 [email protected].