In days gone by, success in school was measured by the mastery of “The Three R’s”: (R)eading, w(R)iting, and a(R)ithmetic. Success is measured in business by mastery of its own “Three R’s”: (R)ecruit, (R)eward, and (R)etain Key Employees. The great industrialist, Andrew Carnegie, understood the value of key employees when he said, (and I will paraphrase):
“…Take away all my factories, railroads, and assets, but leave me my key employees and I will have it all back in a few years.”
The purpose of this article is to focus on the Employee Restricted Bonus Plan. Small businesses can utilize this plan to retain quality executives, increase loyalty, and encourage profitable work habits. In the following sections I will explain what the plan is, how it works, and the advantages to the employer and employee. Since tax laws do change, you must seek legal, tax, and life insurance advice from competent professionals to determine the appropriateness of plan design and the status of current tax benefits to your company.
Let me first define what is meant by the term “Non-Qualified Plan.” Non-Qualified simply refers to plans that do not require adherence to the onerous non-discriminatory requirements and IRS approval of benefit plans such as health insurance and 401K plans. In other words, you get to pick and choose which employees are included and there is little if any government paperwork required for the plan. Non-Qualified Plans are designed to provide benefits to select employees and often include advantageous tax benefits. When cash value life insurance is used as the funding vehicle, the benefits can include:
- Increased financial security for the employee’s family.
- Supplemental retirement income.
- Estate settlement cost funding.
- Funding business continuation plans.
- Tax-deferred growth.
- Tax-free death benefit.
The tax benefits depend on the ownership structure of your company. This includes C corporations, S corporations, LLC’s, LLP’s, partnerships, and sole proprietorships. Please consult your tax advisor to determine any tax consequences of the plans discussed.
How the Employee Restricted Bonus Plan works:
This plan involves an agreement between the employer and employee in which the employer agrees to pay premiums, in the form of a bonus, on a cash value life insurance policy owned by the employee. The “Plan” creates employee loyalty by providing the employee’s family with added financial security through the death benefit paid to them as beneficiaries and at retirement the policy’s cash values can provide supplemental retirement income. Under current tax law both the death benefit and retirement income would be received tax free.
There are a number of different design alternatives that make the “ Plan” a flexible tool for the small business owner. These include the single bonus and double bonus. With the single bonus technique the key employee pays the tax on the bonus. With the double bonus both the premium amount for the policy and the tax due on the bonus are paid to the employee, thus the key person has no out of pocket cost. In its most basic form, the Plan involves 4 Steps.
Step One- The business and the key employee enter into an agreement. The employer will pay the tax deductible premiums on a policy that is owned by the executive. In return, the employee does not have access to the accumulated cash values for a certain time frame or until retirement. The policy death benefit will always be paid to the employee’s beneficiary. In this way, the employer secures the services of the employee as stipulated in the agreement. The employee receives an additional benefit as long as the terms of the agreement are fulfilled.
Step Two- The employee applies for a life insurance policy with a Restriction of Ownership clause that spells out the limits of access to policy values.
Step Three- The employer pays the bonus to the employee. The employee pays the premium to the life insurance company.
Step Four- Upon completion of the terms of the agreement, the employee can access the policy values for any purpose, such as retirement. The life insurance company pays the income tax free death benefit to the named beneficiary.
To determine if this Non-Qualified Plan or other types of plans are feasible for your company you can receive a free Non-Qualified Plan Questionnaire by emailing your request to firstname.lastname@example.org. As always, if you have a Northeast Ohio business story idea please contact me at the above email address with your topic.