What Are the Most Popular Life Insurance Based Nonqualified Plans?
The post-COVID resignation boom has brought employee retention issues to the forefront. With turnover rates on the increase business owners are keenly aware of how difficult it is to attract and retain key personnel. The competition for superior technical, managerial, and executive talent is so fierce today that business owners are constantly faced with finding ways to make executive compensation packages more attractive. However, restrictive economic and regulatory factors make it difficult to reward key contributors using traditional compensation and benefit strategies.
Tax-Qualified Plans Often are NOT the Complete Solution
Most employers use tax-qualified plans such as 401(k), SEP or profit-sharing plans as the cornerstone of their executive compensation package because they are able to deduct the cost of the benefit while the executive avoids including the money in income until distributed. However, while tax-qualified plans are a good starting point, they often are not the complete answer which is why many business owners turn to nonqualified strategies.
Nonqualified Plans Can Be Customized
Nonqualified plans can be structured to enable your business clients to provide benefits that address precise business objectives to benefit only selected key executives the company wishes to reward and retain. Some of the arrangements even allow funding the plan in a way that will help the company recapture the plan cost. Bottom line, when it comes to benefit levels, eligibility, and control of plan
assets, the business owner is the one with the power to make the decisions in a nonqualified plan.
Life Insurance Based Nonqualified Plans
Life insurance can play an important role in a number of nonqualified plan designs. Following are some of the most popular nonqualified plans where life insurance is used as an informal funding tool:
- Executive Bonus/Section 162 Plan: Under this plan the executive acquires a life insurance policy and the business pays for it. The premiums may be deductible as a business payroll expense as long as the executive’s total compensation is considered reasonable. Of course, this amount will be taxable as income to the executive. At retirement the cash value of the policy can be accessed on a tax-favored basis by the executive to help supplement other retirement income sources. (1)
- Restrictive Executive Bonus/REBA: This arrangement is similar to the above executive bonus
arrangement in that the executive owns the policy and the business pays the premiums. However, with this arrangement, the executive’s ability to access the policy cash value is limited through the use of a restrictive endorsement placed on the underlying policy. The restriction acts as a kind of “golden handcuff” encouraging the executive to stay with the business.
- Split Dollar: With this arrangement the business facilitates the purchase and pays most or all of the premiums on a permanent life insurance policy. The business acquires sufficient interest in the policy so that its premium advances are repaid by a share of the policy proceeds with the executive’s beneficiary receiving the balance of the proceeds.
- Deferred Compensation/SERP: Referred to by various names, these plans are contractual arrangements between the employer and executive. These plans provide income tax-deferred supplemental retirement, death, and/or disability benefits at a particular event, such as retirement, death, disability or termination of employment. The employer can specify a minimum service requirement before the executive qualifies for the benefit. Benefit payments, which may be in installments of specified amounts and duration, are generally tax deductible to the business and taxable to the executive when paid.
How DBS Can Help?
As you can see, there are several nonqualified plans available to help you help your business clients
supplement the benefit plans for their key executives. To learn more about how a nonqualified plan can benefit your business clients contact your dedicated Case Design Analyst.
(1) Life insurance policy cash values are accessed through withdrawals and/or loans. Loans are at interest. Unpaid loans and withdrawals cause a reduction in policy cash values and death benefits, may affect any guarantees against lapse, and may have tax consequences. In general, loans are not taxable, but withdrawals are taxable to the extent they exceed basis in the policy. For policies that are Modified Endowment Contracts, distributions (including loans and withdrawals) will be taxed to the extent of income in the contract, and the taxable amount may be subject to an additional 10% federal income tax penalty prior to the contract owner’s attaining age 59 ½.