Executive Bonus
Plans:
Rewarding Employee
Performance
Rewarding employee performance strengthens the stability of
a business and reduces turnover among the ranks of valuable employees. Losing
an important employee to a competitor can disrupt current and future business
profitability.
Privately-held business 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 International 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 employee and further
increases the likelihood that the employee will remain with the company.
These restrictions are often referred to as “golden
handcuffs” and such plans are known as “Restrictive Executive Bonus
Arrangements.”
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 of cash values by the employee for
a selected period of time, such as until the employee’s for a selected period
of time, such as until 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 of an employee’s right 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 liming the
employee’s access to cash values, can be enforced using a policy 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 purpose 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 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 employee win. The employer benefits from greater employee loyalty
and lower staff turnover; the employee benefits from expanded compensation
options.
Bonus Plan Benefits
Benefits to the Employer:
- A
current income tax deduction for compensation paid and a benefit provided
to the employee.
- Employer
can discriminate in selecting the employees who will receive the benefit.
- Employer
can establish performance goals that must be reached for the employee to
receive bonus.
- Easy
to install and administer.
- Helps
retain valued employees.
Benefits to the the Employee:
- A cash
bonus is provided to cover cost of permanent life insurance coverage.
- Employee’s
out-of-pocket cost is limited to income tax owed on the bonus paid.
- Insurance
policy cash value grows tax-deferred to provide supplemental retirement
income
- Additional
family protection is provided in the event of a premature death
- Employee
owns the life insurance policy and names policy beneficiaries.
-article taken from Columbus Life Advanced
Markets Insights, Columbus Life Insurance Company, 400 E. 4th
Street, Cincinnati, OH 45202-3302. From September 2011http://www.newsadinsurance.com/
