Give Your Key Employees Retirement Benefits
 

As a small business owner you may worry about the possibility of losing key people to competitors. Non-qualified retirement plans may help you keep them. “With non-qualified plans you can pick and choose which employees you want to reward,” explains Curt Wilkerson, PSA’s vice president, Financial Services. “You can use them to retain and indemnify certain key people. The plans are sometimes called ‘golden handcuffs’ because the benefits employees receive are attractive enough to make them want to stay with the company.”

There are three basic types of non-qualified plans.

Section 162 plan
“The most simplistic is the executive bonus program, called a Section 162 plan after the IRS code that allows for it,” Wilkerson explains. “They require no documentation, no lawyers, and no contracts. Owners can do this for one or a few employees or for themselves if they have a closed corporation.” Under this plan, employees receive a bonus that they use to purchase a life insurance policy. The policy accumulates cash value and has a death benefit payable to the employee’s choice of beneficiary. The owner promises bonuses in future years so the employees can continue to pay premiums.

Upon retirement age, the employees can start withdrawing the policy basis tax free as supplemental income. Once the basis is gone, they can borrow against the policy’s cash value with no-interest loans. At death, the remaining death benefit is paid income tax free. Employees are taxed on their bonuses up front, but employers can provide a double bonus to help with those taxes. The employer gets a tax deduction up front, but does not have control of the employee’s policy. If an employee decides to leave the company, an employer does not get anything for the policy payments that have been made.

Deferred compensation
“Deferred compensation programs have been tightened up in the last year with tax law changes and IRS regulations,” Wilkerson says. “In the past you could decide on December 30 whether to defer your bonus to some point in the future; now you have to declare your decision a year in advance.” In basic deferred compensation programs, the employer buys a life insurance policy in the name of the employee in lieu of a cash bonus. The company retains control of the policy as the owner and the beneficiary, but can promise to pay a death benefit to the employee’s family. Money accumulates in the policy tax deferred.

When the individual retires, the company takes out the basis and loans, paying out an agreed upon sum to the employee (this could be over a period of years) or a death benefit to the family if necessary. The income employees receive is taxed at their regular rate and the amount paid out is deductible to the corporation. Under deferred compensation plans, employees do not have up-front tax liability. If the company runs into financial trouble in the future, however, creditors can attach the assets in the deferred compensation program. Owners of closed corporations looking to provide retirement income for themselves generally do not favor deferred compensation programs. They prefer to move their money out of the business to safeguard it from creditors.

Split-dollar plans
“Split dollar plans involve a life insurance plan that two parties—the company and the employee—own at the same time. They split the ownership and the payments,” explains Wilkerson. “The employee might be the primary owner of the policy with the employer having a collateral assignment equal to the amount of premiums they’ve paid over the years. Then, when the cash value of the policy exceeds the amount of the premium, the employer will get money back and the employee has the death benefit.” With split dollar plans, employers have some control of the policy and get some deductions (roughly the amount the employee receives as a bonus to pay his part of the premium).

“This type of plan has been around since the mid-1950s and was very attractive until about four years ago, when the IRS got a hold of it,” says Wilkerson. “You used to be able to move cash from employers to employees without paying much tax, but the IRS has changed that.” Since split dollar plans require a great deal of administrative work (keeping track of who is entitled to what), the companies that offer them may also provide any necessary administrative systems.

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Business insurance & planning, estate planning and family wealth preservation (More)