Executive bonus plans can boost employee retention by incentivizing key employees to stay. Offering a Section 162 executive bonus plan allows businesses to reward top performers without providing the same benefits to all employees. The business can pay life insurance premiums for executives and deduct the cost, while the income is taxable to the employee. To offset the tax burden, the bonus can be increased or the business can loan money for taxes. This system of "golden handcuffs" encourages executives to remain for long periods like retirement. The plans provide benefits like cash value that executives can use for retirement income or exchange for annuities.
2. Employee retention is a primary goal for many small businesses. Not only is it
expensive to replace employees, but high employee turnover can be damaging to
workplace morale and customer service.
Itâs especially important to many small businesses to hold onto their key managers and
executives â these are often the employees who give your business the competitive
edge. Not surprisingly, your competitors may try to come after them and lure them away
with a higher salary or more lucrative benefits package.
One way to possibly hold onto your most valuable employees is to offer them a unique
employee benefit known as a Section 162 Executive Bonus Plan. âThis is a non-
qualified plan that enables you to reward your key employees and top performers (and
yourself) without having to offer the same benefit to your rank-and-file workers,â
explains David Lerner Associates Executive Vice President Martin Lerner.
How It Works
With an Executive Bonus plan, you would pay via a bonus the premiums (in whole or in
part) for a whole life insurance policy with a cash value feature for your key
employee(s). This payment would be tax-deductible to your business, while the income
would be taxable to the employee. âTo help ease this tax burden for the employee, you
could increase the employeeâs bonus payment by an amount equal to the tax thatâs due
â a technique known as a Double Bonus plan,â says Lerner.
For example, assume that the annual premium for an insurance policy for your
employee John is $10,000 and John is in the 30 percent tax bracket. You would pay
John a total bonus amount of $14,286 ($10,000 /1 â tax rate), which would net John a
total of $10,000 to cover the premium payment. Meanwhile, your business would be
able to deduct the full $14,286. Alternatively, you could loan John the money for the
taxes via a Leveraged 162 Bonus plan.
When John retires or leaves your business, the loan would have to be paid back to the
business, either out of his pocket or via policy loans and/or withdrawals. However, you
can agree to forgive the loan if John meets certain requirements, such as staying with
your company for a certain number of years. âIn this way, a Leveraged 162 Bonus plan
can serve as âgolden handcuffsâ that incent John to stay with your company over the
long term â perhaps even until he retires,â says Lerner.
Itâs important to note that if loan forgiveness is illustrated, your Leveraged 162 Bonus
plan may be subject to the requirements of Internal Revenue Code Section 409A and
the Employee Retirement Income Security Act (ERISA) as a deferred compensation
plan. These involve the requirement of a written plan document as well as other
additional filing and legal requirements on the part of your business.
More Employee Benefits
3. Another benefit for employees of an Executive Bonus or Leveraged 162 Bonus plan is
the fact that the life insurance policy is solely owned by the employee. Therefore, it
would not be subject to your businessâs creditors should your business become
insolvent. Under most other types of deferred compensation plans, employees are
considered to be unsecured creditors in the event of their employerâs bankruptcy.
In order to realize the benefits of the plan upon retirement, John can take loans and/or
distributions from the planâs cash value to help supplement his retirement income
(although any surrenders and/or loans will reduce the policyâs cash value and death
benefit). And if he doesnât need the death benefit, he could possibly exchange the cash
value into an annuity that would provide an income stream in retirement.
IMPORTANT DISCLOSURES
Material contained in this article is provided for information purposes only and is not
intended to be used in connection with the evaluation of any investments offered by
David Lerner Associates, Inc. This material does not constitute an offer or
recommendation to buy or sell securities and should not be considered in connection
with the purchase or sale of securities.
To the extent that this material concerns tax matters, it is not intended or written to be
used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may
be imposed by law. Each taxpayer should seek independent advice from a tax
professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based
upon publicly available information from sources believed to be reliable-- we cannot
assure the accuracy or completeness of these materials. The information in these
materials may change at any time and without notice.
David Lerner Associates does not provide tax or legal advice. The information
presented here is not specific to any individual's personal circumstances.
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