Executive Bonus Plan Mark Simon

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  • As a businessowner, you have special areas of interest with regard to fringe-benefit planning.
  • This discussion addresses executive bonus planning concepts in general. It does not attempt to address all the intricacies and nuances of your individual circumstances or the laws of your state. Therefore, your specific tax and legal questions should be addressed to your tax and legal advisers.
  • Fringe benefits don’t have to be difficult or complicated to offer value to your executives. In fact, a simple plan is often the best plan. An executive bonus plan is a simple, yet powerful, fringe-benefit plan.
  • No doubt, you have people in your business who are vital to the continued success of your organization. Owners, executives, company officers and other key employees are a business’s most valuable assets.
  • Wouldn’t you like to take steps to motivate, retain and reward your most valuable players? You probably have heard the term “golden handcuffs.” Golden handcuffs refer to executive fringe-benefits plans that are too valuable to walk away from. An executive bonus plan is such a plan.
  • A typical executive bonus plan takes advantage of tax-deductible contributions to fund life insurance policies covering the lives of your key executives. Executive bonus plans are an excellent way to attract, retain and reward the “best of the best” in your business.
  • The benefits to you as a businessowner are valuable: Attracting top employees to your business is probably an ongoing goal. As a fringe benefit, executive bonus plans are an excellent way to attract the “best of the best” to your business. Key employee retention and motivation is enhanced with executive bonus plans. If the executive leaves the company, premium payments made by the employer will cease. Therefore, the executive is financially encouraged to stay with your company, creating greater employee loyalty. Also, the plans can be used as an incentive program to motivate maximum performance from key executives. Executive bonus plans are simple . No IRS approval is required and the plan is easy to administer. Selectivity is key . With executive bonus plans, you pick and choose plan participants. You are not bound by the nondiscrimination rules associated with qualified retirement plans. Executive bonus plans are flexible . Plans can be designed to fit any number of situations and you can also decide how much to contribute for each employee. The tax advantages are significant . Your business receives a tax deduction for premium payments as long as they are reasonable under Section 162 of the Internal Revenue Code.
  • There are several valuable benefits to your executives: Life insurance protection is provided at little cost to the executive. It also frees up funds that the executive would otherwise have to use for personally purchased life insurance. The life insurance policy is portable . The executive has the ability to take the policy with him/her if the executive leaves the company. It should be noted, however, that the executive would have to pay all future premiums if he/she leaves the company. The policy may be protected from claims of creditors . Many states have favorable laws protecting the policy and its cash values from the claims of creditors. These laws vary by state. Your executive also benefits from tax advantages including income-tax free death benefits and tax advantaged access to policy cash values (under current tax laws).
  • Qualified retirement plans are federally approved plans that have several major tax benefits. Employer contributions are deducted for income tax purposes and money accumulates on a tax-deferred basis to provide retirement, disability and death benefits. Executive bonus plans incorporate all of these features.
  • An executive bonus plan includes the best features of a qualified plan and eliminates its worst features. Unlike qualified plans that have non-discrimination rules for participation, executive bonus plans allow you to pick and choose participants among your key executives. Executive bonus plans also eliminate the cumbersome government filings, paperwork and administration associated with qualified plans.
  • Executive bonus plans share many of the advantages of qualified plans, while maintaining employer control and avoiding ERISA requirements. Under a qualified plan, if the plan owns the life insurance policy, the employee is taxed applying applicable term rates.
  • It is said that many highly compensated employees are faced with “reverse discrimination” when it comes to retirement plan benefits. It is common for companies with pension plans to pay employees a minimum of 60% of final salary. However, the federal government imposes limits on how much can be paid by pension plans. In 2009, because of the limit, employees earning over $245,000 will not receive 60% of their final salary. As a matter of fact, the more you earn, the lower the percentage you will receive. This comparison illustrates the potential reverse discrimination that pension plans have against highly compensated employees. It depicts retirement income as a percentage of final salary from a qualified retirement plan (such as a defined benefit pension plan) for the salaries listed. For example, an executive earning $300,000 will receive $147,000 a year in retirement benefits. That’s only 49% of salary as compared to 60% paid to the employee earning $200,000.
  • Executive bonus plans are often used to overcome the reverse discrimination that qualified plans have against highly compensated employees.
  • Here’s how an executive bonus plan works. Your business purchases an insurance policy on the life of each participant you select. Each premium payment is a tax-deductible business expense and is taxed to the executive as income. The executive is the owner of the policy and names his/her policy beneficiaries. The policy cash values accumulate on a tax-deferred basis and can be accessed as needs arise (such as for college funding or for retirement income). If properly structured, the policy values are accessed on a tax-advantaged basis and are free from the claims of the executive’s creditors (subject to state-specific laws). In the event of the executive’s death, policy death benefits are paid income-tax free to the executive’s beneficiaries or heirs (and can be earmarked to pay estate settlement costs such as estate taxes and /or final expenses).
  • Let’s take a few minutes to discuss the basic income, estate and gift tax aspects of executive bonus plans. As stated earlier, one of the primary advantages of an executive bonus plan is its simplicity. The tax consequences of an executive bonus plan are fairly straightforward, but you should still consult with your tax specialist if you have specific questions.
  • Internal Revenue Code Section 162 permits an employer to take deductions for ordinary and necessary business expenses. This includes deductions for reasonable salaries or other compensation for personal services. A properly structured executive bonus plan qualifies for such a deduction. Because the bonus is paid to the executive in the form of an insurance premium for a policy owned by the executive, it avoids exposure to the corporate alternative minimum tax.
  • Premiums paid by the employer are taxed to the executive as income, but at the executive’s death, policy death benefits are paid to the executive’s beneficiaries or heirs, income-tax free. At retirement, the executive can take annual withdrawals or loans of cash values from the policy. The executive can also use the policy cash values for any other need that he/she deems necessary. Of course, the amount of income available will depend on the amount of premiums paid over the years, as well as the executive’s age and health at the time the policy is purchased and the performance of the product chosen.
  • An individual who is included in an executive bonus plan typically will own the life insurance policy that is part of the plan. As the owner, the life insurance proceeds will be included in the executive’s estate at the time of death. To remove the policy from the executive’s estate, it would be necessary for the insured to transfer the policy to a third party such as one of the executive’s children or an irrevocable life insurance trust. If the transfer of a life insurance policy is made within three years of the insured’s death, the policy is drawn back into the executive’s estate.
  • Some executives facing a potential estate-tax problem decide to gift their policy to a trust or third-party owner in order to avoid estate taxes on the death benefit. This is an appropriate strategy in some cases, but it may trigger federal gift taxes. Each person has an annual amount that he/she can gift without triggering the gift tax. This is known as the “annual gift tax exclusion amount.” For 2009, the annual gift tax exclusion amount is $13,000 per donee (or $26,000 per donee if a married couple gifts together). Every person also has a “lifetime gift tax exemption amount” of $1,000,000. The lifetime exemption amount can be used to shield gifts exceeding the annual exclusion amount. When a gift of a life insurance policy is made, the value of the gift is typically the policy’s cash surrender value at the time of the gift.
  • As we discussed earlier, flexibility is one of the advantages of executive bonus plans, not only in the choice of participants, but also in the choice of design. Let’s look at a few of the basic variations of executive bonus: custodial executive bonus, double bonus and executive contribution.
  • Custodial executive bonus adds the element of employer control. The employer and executive enter into an agreement that details the restrictions placed on the executive’s ability to exercise policy ownership rights. During the term of the plan, the executive needs the employer’s consent to access the policy cash value or to make other important policy decisions.
  • Custodial executive bonus works the same as a regular executive bonus with the added element of employer control.
  • The concerns that trigger the custodial arrangement include worry that the executive will leave the company and perhaps use the policy cash value buildup to start a competitive business venture. Typically, the restrictions remain in place until the executive reaches a specified retirement age or satisfies a length-of-service requirement. Once the required conditions have been met, the executive is free to exercise all ownership rights without any restrictions. At no time does the employer ever own the policy in a custodial executive bonus plan or have any reversionary interest. The policy can never revert to the employer under any circumstances.
  • When comparing executive bonus and custodial executive bonus, employer control is a critical difference. If control over policy ownership rights and control over access to policy cash values are important issues to you, then custodial executive bonus might be the right plan for your business.
  • With this alternative, the employer bonuses all of the premium, plus an additional sum, to cover the income tax due by virtue of the executive bonus plan. Because the executive is reimbursed for the tax outlay, he or she doesn’t have to reach into his or her own pocket to pay income taxes or use the life insurance policy as a tax payment source.
  • The double bonus is added by the employer to cover out-of-pocket taxes due by the employee.
  • The third variation of a standard plan allows the executive to add his or her own contribution to the premium. Once the employer determines a premium amount, the executive may contribute his or her own money to supplement the fringe benefit plan. Employee contributions are nondeductible, but the death benefit is income-tax free, and the employee enjoys tax-advantaged access to policy cash values under current tax laws.
  • With executive contribution, the employee pays a portion of the premium to increase the policy cash value and death benefit.
  • I would like to show you how executive bonus plans can fit into your executive compensation plan. In order to get started, I need some basic information from you. (See slide for list of required information.)
  • Executive Bonus Plan Mark Simon

    1. 1. Executive Bonus Plan Presented To: Presented By: Mark L. Simon Financial Services Professional California Insurance License No. 0E41454
    2. 2. Please Be Advised: <ul><li>All specific legal and tax questions should be referred to your legal and tax advisers. </li></ul>
    3. 3. Executive Bonus Plan <ul><li>Reward your key people with a simple yet powerful fringe-benefit plan. </li></ul>
    4. 4. Consider This <ul><li>Which of your employees is vital to the success of your business? </li></ul><ul><li>Owners? </li></ul><ul><li>Executives? </li></ul><ul><li>Officers? </li></ul><ul><li>Key Employees? </li></ul>
    5. 5. Key People Are Valuable! <ul><li>Wouldn’t you like to take steps to retain, motivate and reward them? </li></ul>Tip: Take steps to place “golden handcuffs” on your most important people.
    6. 6. A Simple Yet Powerful Solution <ul><li>An executive bonus plan uses tax-deductible contributions to fund insurance policies covering the lives of your key people. </li></ul>Attract Motivate Retain
    7. 7. Plan Benefits <ul><li>For you as a businessowner: </li></ul><ul><li>Attracts the best of the best </li></ul><ul><li>Key employee retention and motivation </li></ul><ul><li>Simplicity </li></ul><ul><li>Selectivity </li></ul><ul><li>Flexibility </li></ul><ul><li>Tax deduction </li></ul>
    8. 8. Plan Benefits <ul><li>For your key people: </li></ul><ul><ul><li>Life insurance protection </li></ul></ul><ul><ul><li>Portability </li></ul></ul><ul><ul><li>Policy cash values may be creditor protected* </li></ul></ul><ul><ul><li>Income-tax free death benefits** </li></ul></ul><ul><ul><li>Tax-advantaged access to policy cash values** </li></ul></ul>* Creditor protection varies by state ** Under current tax laws
    9. 9. Incorporate the Best Features of Qualified Retirement Plans <ul><li>Create a tax-deductible business expense </li></ul><ul><li>Accumulate money on a tax-deferred basis </li></ul><ul><li>Provide benefits for retirement, disability and death </li></ul>
    10. 10. Avoid the Worst Features of Qualified Retirement Plans <ul><li>Allow for choice of participants </li></ul><ul><li>Eliminate government filings and paperwork </li></ul><ul><li>Significantly reduce administration </li></ul>
    11. 11. Comparison of Fringe-Benefit Plans Qualified Plan Executive Bonus Contributions deductible by employer Yes Yes Contributions taxable to executive No Yes Receipt of retirement income taxable to executive Yes No ERISA requirements Yes No
    12. 12. A Level Playing Field? *Comparison assumes a qualified retirement plan benefit of 60 percent of final salaries shown above, subject to the IRC section 401(a) compensation limit of $245,000 for 2008. Comparison of retirement benefits as a percentage of final salary*
    13. 13. Executive Bonus as a Supplement to Qualified Plans <ul><li>Use Executive Bonus to overcome the “reverse discrimination” that pension plans have against highly compensated individuals. </li></ul>
    14. 14. How it Works Business pays the premium Business receives a tax deduction Insurance policy is purchased Business Executive Heirs Insurance co. Premium is a taxable bonus Executive owns the policy <ul><li>Executive is taxed on bonus </li></ul><ul><li>Cash values build tax-deferred </li></ul><ul><li>Policy cash values available for retirement or college funding </li></ul><ul><li>Cash values may be creditor protected (varies by state) </li></ul><ul><li>Death benefits may be used for estate settlement </li></ul>Income-tax free death benefit and access to policy cash value
    15. 15. Tax Aspects <ul><li>Income Tax </li></ul><ul><li>Estate Tax </li></ul><ul><li>Gift Tax </li></ul>
    16. 16. Income Tax: Employer <ul><li>Premium payments qualify employer for an income-tax deduction </li></ul><ul><ul><li>An ordinary and necessary business expense </li></ul></ul><ul><ul><li>No exposure to the alternative minimum tax </li></ul></ul>
    17. 17. Income Tax: Executive <ul><li>Premiums paid by the employer are taxed to the executive </li></ul><ul><li>Income-tax free death benefits </li></ul><ul><li>Tax-advantaged access to policy cash values for: </li></ul><ul><ul><li>Retirement income </li></ul></ul><ul><ul><li>College expenses </li></ul></ul><ul><ul><li>Other needs </li></ul></ul>
    18. 18. Estate Tax <ul><li>Life insurance proceeds are included in the executive’s estate </li></ul>Tip: To remove the policy from the executive’s estate, consider transferring the policy to a third party such as a child or an irrevocable life insurance trust.
    19. 19. Gift Tax <ul><li>If the employee gifts the policy to a third party, the gift may be taxable, subject to the annual gift tax exclusion and lifetime exemption amounts </li></ul>Tip: The value of the gift is typically the policy’s cash value at the time of the gift.
    20. 20. Plan Design Alternatives <ul><li>Custodial Executive Bonus </li></ul><ul><li>Double Bonus </li></ul><ul><li>Executive Contribution </li></ul>
    21. 21. Custodial Executive Bonus <ul><li>Allows employer to place restrictions on the employee’s ability to exercise policy ownership rights. </li></ul><ul><li>Restricts access to policy cash values </li></ul><ul><li>Restriction removed after a stated period of time </li></ul><ul><li>Enhances employer control </li></ul>
    22. 22. How Custodial Executive Bonus Works Business pays the premium Business receives a tax deduction Insurance policy is purchased Business Executive Heirs Insurance co. Premium is a taxable bonus Executive owns the policy <ul><li>Cash values build tax-deferred </li></ul><ul><li>Proceeds may be used for estate settlement </li></ul><ul><li>Accumulated cash value for retirement or college funding , subject to employer’s consent </li></ul><ul><li>Cash values free from claims of creditors </li></ul><ul><li>Employer has “veto” power over executive’s access to policy cash values </li></ul>Employer restricts executive’s ability to exercise ownership rights Income-tax free death benefit
    23. 23. When to Use Custodial Executive Bonus <ul><li>To prevent a competitive start-up by the executive </li></ul><ul><li>To give the employer control over exercise-of-ownership rights </li></ul><ul><li>To force the employee to save for retirement </li></ul>Tip: This type of arrangement gives the employer “veto” power over the executive’s access to policy cash values.
    24. 24. It’s About Control Executive Bonus Custodial Executive Bonus Contributions Deductible by Employer Yes Yes Contributions Taxable to Executive Yes Yes Receipt of Retirement Income Taxable to Executive No No ERISA Requirements No No Enhanced Employer Control No Yes
    25. 25. Double Bonus <ul><li>Employer bonuses an additional sum to cover taxes due from the executive bonus plan. </li></ul>Tip: With a double bonus, the executive doesn’t have to reach into his/her own pocket to pay taxes.
    26. 26. How Double Bonus Works Business pays the premium Business receives a tax deduction Insurance policy is purchased Business Executive Income-tax free death benefit and access to policy cash value Heirs Insurance Co. Premium is a taxable bonus Executive owns the policy <ul><li>Cash values build tax-deferred </li></ul><ul><li>Proceeds may be used for estate settlement </li></ul><ul><li>Accumulated cash value for retirement or college funding </li></ul><ul><li>Cash values free from claims of creditors </li></ul><ul><li>No out-of-pocket taxes due by executive </li></ul>Employer makes double bonus
    27. 27. Executive Contribution <ul><li>Allows employee to add their own money to the premium. </li></ul><ul><li>Increases death benefit and cash value available under the policy funding the plan </li></ul><ul><li>Supplements retirement savings </li></ul>
    28. 28. How Executive Contribution Works Business pays the premium Business receives a tax deduction Insurance policy is purchased Business Executive Heirs Insurance Co. Premium is a taxable bonus Executive owns the policy <ul><li>Cash values build tax-deferred </li></ul><ul><li>Proceeds may be used for estate settlement </li></ul><ul><li>Accumulated cash value for retirement or college funding </li></ul><ul><li>Cash values free from claims of creditors </li></ul><ul><li>Executive’s contribution increases policy cash value and death benefit </li></ul>Executive’s contribution Executive’s contribution increases policy cash value and death benefit
    29. 29. Initiating a Plan Required Information Name, gender and date of birth of executives to be covered Amount of coverage desired or premium commitment Tax brackets of the business and individual executive(s)

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