Enhancing Retirement Benefits For Owners And Key Executives

A critical factor in the success of an organization is attracting and retaining the best employees and key executives. Part of this effort includes assembling a competitive compensation package, including a retirement plan.

Companies considering how to provide retirement benefits for their employees often adopt a qualified defined contribution plan, such as a 401(k). For some businesses, though, a nonqualified plan using variable universal life insurance contracts provides an alternative for owners and executives.

While 401(k) plans and other qualified plans offer significant benefits for employees, they also present challenges for business owners who want to accumulate significant retirement savings for themselves and their key executives. One major issue is that qualified plans place strict contribution limits on all employees, including executives. Often, a supplemental nonqualified deferred compensation (NQDC) program is used to offset these limits, an approach that provides advantages for many companies.

However, “pass-through” entities like S-corporations and limited liability companies (LLCs), which distribute profits and losses to individual owners who pay the taxes due on the profits or deduct the losses, don’t enjoy the same advantages. Traditional NQDC plans also delay the employer deduction until benefit dollars are paid out. Another key concern is that all deferred amounts are potentially subject to the company’s creditors.

One solution is a variable universal life insurance contract in which employer contributions are made in the form of premium payments.

Illustration

Consider the following case: A construction company, set up as an S Corp. with 350 employees, established a 401(k) plan as part of a competitive benefits package for its employees. However, due to high employee turnover among hourly workers, hourly employee 401(k) plan participation was very poor.

Each year the company failed its nondiscrimination tests (ADP/ACP), leaving the firm’s owner and several higher paid key executives unable to contribute the maximum amounts to the plan. As a result of the nondiscrimination testing, the owner and several executives received 401(k) contribution checks back each year from the plan administrator.

Because the owner wanted to increase his own retirement savings opportunities and reward the key executives, he needed a retirement savings option in addition to the 401(k) plan. A traditional nonqualified deferred compensation plan was not the preferred option for tax reasons. Instead, he voluntarily limited his 401(k) contribution to his prior year’s nondiscrimination test limit.