Executive Bonus Plans: Rewarding Employee Performance
Rewarding employee performance strengthens the stability of
a business and reduces employee turnover among the ranks of valuable
employees. Losing an important employee
to a competitor can disrupt current and future business profitability.
Privately-held businesses entities have limited options when
designing compensation packages for their employees. Many small companies are unwilling to
establish qualified retirement plans because of the high cost of the plans and
because they have to include all eligible employees.
Nonqualified deferred compensation plans are an option but
participation is restricted to certain highly paid management employees. Having benefits in addition to normal
compensation is a proven method for improving employee morale and job
satisfaction and thereby reducing costly employee turnover.
An Executive Bonus Plan (also known as a Section 162 plan
after the section of the Internal Revenue Code that permits an employee to
deduct compensation paid to employees) offers the opportunity to reward any
employee. It could be a one-off bonus
for exceptional work in any year or, more commonly, an on-going arrangement to
provide additional compensation annually.
To enhance the future value to the employee and the employee’s family,
the payment is usually paid as the premium for a cash value life insurance or
annuity contract owned by the employee.
Attaching conditions, such as job performance or continued
employment, to the right to continue receiving this additional compensation
increases the attractiveness of such a plan to the employer and further
increases the likelihood that the employee will remain with the company.
The employee is responsible for payment of income tax on the
bonus paid by the employer. In some
cases, the employer will pay an additional amount to cover the associated
income tax liability in which case the plan is known as a “double bonus” plan.
As long as the bonus represents “reasonable compensation”,
the business can deduct the bonus used to pay the life insurance policy
premium. The employee owns the life
insurance policy and names his or her beneficiary.
An employer can place certain restrictions on the policy as
an incentive to the insured employee to remain with the company. One such restriction can be limiting access
to policy cash values by the employee for a selected period of time, such as
the employee’s expected date of retirement.
Additional
Considerations
Employers should seek legal counsel regarding creating a
formal agreement between the employer and the employee governing the Executive
Bonus Plan. Any corporate records
notation or agreement should spell out who will participate in the executive
bonus program, why such employee or employees were selected for participation,
and the nature of the benefit these employees will receive. Any restrictions on an employee’s rights to
access insurance policy cash value, or any “golden handcuffs” arrangement,
should be spelled out in the written agreement between employer and employee.
Actual restrictions on the policy itself, such as limiting
the employee’s access to cash values, can be enforced using a policy
endorsement filed with the insurance company. The endorsement should indicate the
time period during which policy restrictions will remain in effect, and list
the conditions for removal of any restrictions on the employee’s access to the
policy.
The purposes of a permanent cash value life insurance
Executive Bonus Plan include growing funds on a tax-deferred basis to be made
fully available to the employee for supplemental income in retirement.
From an employee’s perspective there are two concerns with
this type of arrangement. If this is not
a “double bonus” plan, the employee may be concerned about having the funds to
pay the income tax liability. Also the
employee may be concerned about the viability of the life insurance contract if
the employer does not pay the bonus each year.
To address some of these concerns, the employer and the employee could
agree to establish the plan for a limited period and make payments in an amount
sufficient to sustain the policy after the payment period.
With a properly structured executive bonus plan, both the
employer and the employee win. The
employer benefits from greater employee loyalty and lower staff turnover; the
employee benefits from expanded compensation options.
Article written by Columbus Life appeared in Columbus
Tom Newsad has been building relationships for over twenty
years in his community. Newsad Insurance
Services offers life insurance, fixed index annuities, health insurance, and
disability and long term care insurance.
For more info see www.newsadinsurance.com
. Tom serves clients in the Butler , Hamilton,
Montgomery, Warren, Miami ,
and Preble county areas and beyond.
