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The Advantages of an Executive Bonus Plan
By Well-developed Executive Benefit Plans can be a tremendous asset to a company. History teaches us that Executive Benefit Plans have long been an effective tool in recruiting and retaining key executives by helping them save for their future. But what is the cost and how much should a company rightfully spend on funding an Executive Benefit Plan in the current economic climate?
Employers want loyal and hardworking employees. Most employees want to be considered as such. However, in the absence of stock to retain, reward and incentivize, companies with a limited number of key executives and owners of S-Corps are often torn about what route to take when deciding to implement an Executive Benefit Plan. An Executive Bonus Plan can be the perfect opportunity for businesses to balance the need to provide a valuable benefit to executives, while minimizing the cost and risk that the company assumes in doing so.
How Executive Bonus Plans work
With Executive Bonus Plans, the employer uses an executive compensation bonus as premium to purchase an investment grade insurance policy on the executive’s life. These specially designed policies typically credit between 90 – 100% of premium paid as cash value. The company pays the premium payments which are considered ordinary income to the executive. The executive owns the life insurance contract and may use the value of the contract as supplemental tax free retirement income through withdrawals and loans and/or provide a death benefit to his or her beneficiary.
Advantages to the employer
There are a number of advantages for an employer in implementing an Executive Bonus Plan. Executive Bonus Plans, like other nonqualified plans, are discriminatory. The employer is free to choose the eligible group of executives as well as the level of benefits they wish to provide. They may also create restrictions on the executive’s use of the policy value to create an employment incentive. Premium payments made to an Executive Bonus Plan (which can vary based upon performance metrics or other agreed upon variables) are considered compensation to the executive and therefore create a current tax deduction for the employer. In addition, Executive Bonus Plans are very simple to set up and administer and, since they are not subject to IRC 409A Regulations, they do not subject the employer to IRC 409A compliance exposure or the cost of the more intensive administration of a Deferred Compensation Plan.
Advantages to the executive
Executive Bonus Plans offer executives the ability to accumulate substantial income for retirement on a tax-deferred basis. The insurance policy will also provide valuable death benefit protection for the executive’s beneficiaries which, if structured correctly, can be paid estate tax free. The cost to the executive is the tax on the bonus, an amount significantly less than the actual premium payment of the policy. And since the executive owns the insurance policy, it is removed from the claims of corporate creditors (and in Massachusetts, also removed from claims of executive’s creditors) creating a secure retirement accumulation vehicle.
In summary, Executive Bonus Plans are a cost effective compensation tool for employers to help executives accumulate savings for their retirement. With the uncertainty of future tax rates, executives will appreciate a plan that uses after tax bonus compensation that not only accumulates tax free but that can provide tax-deferred income at retirement.
This article was written by Nancy MacDonald. Nancy is the Vice President the Benefit Planning & Administration department at Sapers & Wallack, Inc. For more information about Executive Bonus Plans or other types of executive benefit plans, you are invited to attend Sapers & Wallack’s upcoming seminar (4 CPE credits) on Tuesday, May 18 from 8 am – 12 pm. The seminar is complimentary, however pre-registration is required. To RSVP or for more information, please call Katie Farrow at 617-225-2600 or email kfarrow@sapers-wallack.com.