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Life Insurance as Executive Compensation

Advisors who serve the business market know that one of the most stressful events a business owner can experience is the departure of a key employee. 
 
Advisors serving business owners can help their clients potentially avoid this stress — and at the same time enhance their position as a trusted consultant — by encouraging business owners to consider executive compensation plans for  key employees.
 
Executive compensation plans are an effective way to recruit, retain and reward employees who are valuable and essential to a business. These types of plans can also supplement retirement goals for key executives. It is not unusual to see the most highly paid employees of a company limited on the amounts that can be contributed to a 401(k) or other types of qualified plans. The nonqualified executive plan may be an excellent strategy to make up for this limitation. The employer, often referred to as the plan sponsor, is able to select highly compensated employees and management who will participate.
 
There are five common types of nonqualified executive compensation plans: (1) executive bonus arrangement (Section 162 bonus), (2) golden executive bonus arrangement (GEBA); (3) golden executive match (GEM); (4) split dollar, and (5) nonqualified deferred compensation.
 
Some of these plans currently are income tax-deductible and some are not. A current income tax deduction often is very attractive to the employer, who will likely insist that the nonqualified plan that is implemented is currently tax-deductible. In this article, I will discuss the three types of nonqualified options that are currently income tax-deductible to the employer: executive bonus arrangement, golden executive bonus arrangement and golden executive match.
 
These nonqualified executive compensation plans often use life insurance as the accumulation vehicle. The diagrams show how the arrangement and the ownership of life insurance are intended. Life insurance is typically an effective accumulation vehicle if there is a sufficiently long timeline. Additionally, the tax-deferred growth and the tax-preferred access are attractive to the employee, often referred to as the plan participant.
 
Executive Bonus (Section 162 Bonus)
 
An executive bonus arrangement is a simple, nonqualified executive compensation strategy designed to provide supplemental benefits to key employees. This nonqualified employee benefit arrangement is structured as a compensation bonus to the key employee. It is income tax-deductible to the employer at the time the bonus is made and considered as income to the employee. The bonus is used to pay the premiums on a life insurance policy. The employee is the insured and owner of the life insurance. 
 
Golden Executive Bonus Arrangement (GEBA)
 
The golden executive bonus arrangement is structured as an executive bonus plan. The employee is the insured and owner of the life insurance contract. The employer provides a bonus that is paid into the life insurance contract as premiums. 
 
The bonuses are currently income tax-deductible to the employer and considered as income paid to the employee. 
 
The GEBA differs from the executive bonus plan in two ways. First, it requires an employment agreement specifying that the employee will work a certain number of years in order to receive the benefits. After the term of years is completed, the benefits are completely relinquished to the employee. If the agreement is not completed, the employee contractually owes the employer a specified dollar amount of the bonuses paid. Second, the employer and employee execute an insurance form that is filed with the insurance company. This is the “Policy Instructions” form, which prohibits the employee from surrendering, accessing or pledging the policy until the arrangement is 100 percent vested.
 
Golden Executive Match (GEM)
 
A golden executive match is designed with contributions by the employee as well as a “tax-match bonus” by the employer. 
 
The employee pays premiums into a life insurance policy. The employer agrees to a specific tax-match bonus, which pays the income taxes on the employee’s contribution. Since the employer pays a tax match, the employee is able to contribute more dollars into the GEM plan. The arrangement mimics a pretax contribution but without the complexity of a nonqualified deferred compensation (NQDC) plan, which allows an executive to defer a portion of their compensation — and taxes on that compensation — until the deferral is paid. 
 
GEM is effective when key employees have limitations to qualified plan contributions and/or an NQDC plan is not practical. The employer’s cost is controlled because it pays only a tax-match bonus, rather than the premium and a tax-match bonus. GEM also allows for the employer to recover its proportional contributed costs if the employee leaves before a particular date.
 
GEM also requires two additional steps not associated with an executive bonus plan. First, it requires an employment agreement specifying that the employee will pay the entire tax-match bonus, or a portion of that bonus, to the employer if a specified number of years of employment are not completed. After the term of years is completed, the benefits are completely in the control of the employee. Second, the employer and employee execute an insurance form that is filed with the insurance company. Again, this form prohibits the employee from surrendering, accessing or pledging the policy until the arrangement is 100 percent vested. However, unlike with the GEBA, the employee potentially will be able to access their contributions simply by paying the specified amount of the tax match owed to the employer.
 
These three nonqualified plans provide the employee with a life insurance contract at retirement. The life insurance provides protection in the form of a death benefit. Additionally, the employee can access the cash value to supplement retirement income. The employee also can take tax-preferred loans and withdrawals from the cash value. If the life insurance contract stays in force until death, no income tax will be paid on these retirement dollars.
 
Nonqualified executive compensation plans are essential tools for advisors serving the business market. These types of plans are effective for exit and transition planning and retirement planning, as well as for recruiting, retaining and rewarding those employees who are key to a business. 

J.D., LL.M., CLU, is senior advanced marketing counsel at Securian Financial Group. William may be reached at william. [email protected] william. [email protected].


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