Rewarding key employees
Your key employees make an important contribution to your business’s profitability. It’s in your best interest to keep them satisfied by recognizing their contributions and rewarding their achievements. Selective executive compensation benefits not only allow key employees to share in the accomplishments of the business, they can financially reward employees whose work is most responsible for your business’s success.
Executive Bonus (Section 162)
An Executive Bonus is a tax-deductible way for companies to provide supplemental benefits to key employees.* It allows the company to be selective and reward top performers. You can use this nonqualified employee benefit arrangement to pay a compensation bonus to one or more key employees. The bonus is used to pay the premium on a life insurance policy insuring the key employee’s life. How an Executive Bonus works • Company pays a bonus to the employee. • Employee pays income taxes on the bonus amount. • Company could choose to pay the income taxes for the employee. • Employee takes out a personal life insurance policy and names a beneficiary. • The bonus is used to pay the premium on the life insurance policy • Employee may have living benefits distributed from the policy’s cash value on a tax-preferred basis at retirement. • Death benefits are payable to the employee’s beneficiary.
Golden Executive Bonus Arrangement
A Golden Executive Bonus Arrangement (GEBA) is an executive compensation strategy. It incorporates a bonus vesting schedule to encourage company loyalty and golden handcuff a key employee.* Company bonuses fund a life insurance policy which is owned by the employee. The employee’s access to cash value is restricted until the vesting schedule is complete. If the employee leaves before a predetermined time, all or some of the bonuses must be returned to the company. How a Golden Executive Bonus Arrangement works • Company pays a bonus to fund a life insurance policy. The policy is owned by the employee. • Employee pays income taxes on the bonus amount – the company could choose to pay the income taxes with an additional bonus to the employee. • Two documents golden handcuff the employee: – Policy Instructions signed at the policy’s purchase, restricting the employee’s access to the cash value life insurance contract. – Employment Agreement, drafted by a licensed attorney, specifying the bonus vesting schedule and various other provisions. • Company pays an annual bonus that continues to fund the life insurance policy. • Policy Instructions terminate at the time specified in the Employment Agreement. – Employee gets unrestricted ownership of the policy with its cash value. – Death benefits go the employee’s beneficiary.
Golden Executive Match
A Golden Executive Match (GEM) is an executive compensation strategy. It’s designed with both a key employee1 contribution and a company match. The employee pays a certain amount in premium into a life insurance policy, and the company agrees to bonus a specific tax match. GEM is an effective arrangement when key employees have limited qualified plan contributions and a Nonqualified Deferred Compensation plan isn’t practical. The company can choose to pay the employee a bonus which approximates the income taxes on the life insurance premium paid. GEM also allows for golden handcuffs – the company may recover part or all of its contributed costs if the employee leaves before a particular date. How a Golden Executive Match works • Employee purchases a life insurance policy, using it for both the death benefit and as a tax-preferred vehicle where annual contributions are made. • Company bonuses a tax match to cover income taxes on the life insurance premiums. – Employee can choose to use the money saved on the tax match to put more dollars into the life insurance policy. – Company can choose to attach golden handcuffs and a vesting schedule for its contributions but not the employee’s contributions. – Employee can use the policy’s cash value for supplemental retirement income, withdrawing before age 59½ without a 10 percent penalty.2 • At the employee’s death, the policy’s death benefit is paid out to beneficiaries.
Split-Dollar Life Insurance
What is a split-dollar arrangement? A split-dollar arrangement is a strategy in which a life insurance policy’s premium, cash values, and death benefits are split between two parties (owner and non-owner). It is not a type of life insurance or a reason for buying life insurance; rather, it is a method of financing the purchase of life insurance. Split-dollar is generally most appropriate when one party (usually the business) has the cash to pay the premiums for life insurance and the other party (usually the key employee) has the need for life insurance. Depending upon the method of split-dollar used, the policy owner may be the employer, the insured/ employee, the insured’s trust or a third party. It has been used in various forms to help individuals in estate planning to: • Minimize income and gift taxes connected with the funding of large premiums. • Reduce the cash flow required to fund a life insurance policy. In addition, it has been used by businesses as an executive benefit to: • Encourage employees to remain with the company. • Attract new employees when the business expands or has positions it needs to fill. • Pay the personal life insurance premiums for the owner or select key employee(s) at a potentially lower after-tax cost. Two common split-dollar arrangements and two tax approaches provide considerable design flexibility for the business and the insured employee. There is no “one-size fits-all” answer to the question of how a split-dollar arrangement should be designed. Every situation is unique.
Nonqualified Deferred Compensation
Nonqualified Deferred Compensation (NQDC) is an executive compensation strategy. It provides key employees with a promise to pay benefits sometime in the future, reducing their current taxable income. NQDC can be effective when a company offers a qualified plan, such as a 401(k), and the employees are limited in their contributions. NQDC also allows for golden handcuffs – letting the company recover costs if a valued employee leaves before a particular date. Companies can choose which employees to whom they offer a NQDC plan.
How Nonqualified Deferred Compensation works: Step 1 – NQDC agreement • Company and employee execute certain documents associated with the NQDC plan. • Documents reflect the company’s intentions and its obligations to the employee. • Company’s attorney drafts the NQDC documents and ultimately decides if any further documents are necessary to implement the NQDC plan. Step 2 – Informal funding • Company is free to use any source to informally fund its obligation to pay the NQDC benefits and/or survivorship benefits to the employee. • Life insurance is likely the preferred method.
– Certain types of life insurance can provide cash value accumulation on an income tax-deferred basis.
– Company is the owner and beneficiary of the life insurance policy. The employee is typically the insured but has absolutely no rights or ownership in the life insurance policy.
– Company may choose to meet NQDC retirement benefits out of the cash value of the life insurance on a tax-deferred basis through withdrawals and loans. If the company chooses to pay retirement benefits out of its existing funds and hold the policy until the insured dies, internal gains are not taxed (subject to the alternative minimum tax for C corporations)