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Part of sound business practice is to assure that your key people are compensated in a way that rewards their past performance and encourages future performance. There are several tools available to help you provide targeted benefits to you and your key people. It is not unusual for a business to use more than one of these concepts – building a program that helps meet your unique needs.
Non-qualified plans are plans that you can use to provide additional benefits to yourself and your key employees and executives. A non-qualified plan is often used along with a qualified plan as an additional benefit to attract and retain key employees. They also offer greater flexibility in who can be covered under the program and are generally easy to establish and administer.
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Key Person Protection
If you are like many business owners, much of the success of your business depends on your employees. Often times, there is a core group of contributors who help drive your business. Whether they are part owners or important employees, they bring value to the table. You want to make sure that your business will continue to be successful even if you lose their expertise.
So how do you protect your business when the financial security of your business is threatened by the death of a key person?
You can help cover the financial loss your business would experience at the death of a key employee by insuring your key people.
Key person insurance can be used to:
- Keep lines of credit open.
- Train another employee for the same specialized skills.
- Assure the completion of ongoing project initiatives.
- Provide access to policy cash value through loans and withdrawals, which your business can use to meet unexpected business expenses*.
While you can never replace your key people, you can help protect your business from experiencing financial loss at their death.
An Executive Bonus Plan, also referred to as a Section 162 plan, allows a business to provide personally owned life insurance as a tax-deductible fringe benefit to select key employees.
If the benefit is for a non-owner employee, an executive bonus plan is appropriate for all business forms, including professional corporations, partnerships and LLC’s. However, this type of plan does not offer any tax benefit for business owners if the business is an S-Corp, partnership or LLC taxed as a partnership.
The advantages of an Executive Bonus Plan:
- Employer decides who participates and how much of a bonus each employee will receive.
- Bonus dollars are tax-deductible to the company as compensation to the key employee.
- Simple to adopt with No IRS approval required.
- Premiums are reported as “other compensation” on W-2 and are subject to FICA and FUTA taxes.
- The key employee will own and control the policy and will have access to the riders, potential cash value growth and death benefit that make up the permanent life insurance policy.
- The employee’s out-of-pocket cost is the tax due on the premiums paid by the employer that have been treated as compensation. You may choose to add a cash bonus to the arrangement (a double bonus) to offset the tax amount due.
- Policy cash value grows tax-deferred and may be accessed through withdrawals or policy loans*.
- Death benefit is paid to the insured’s beneficiaries income tax-free.
A Split dollar plan offers a creative solution to helping your key employee obtain needed life insurance.
Split dollar is a term that covers two different executive benefit arrangements.
- The Split Dollar Economic Benefit arrangement provides an income tax-free death benefit to the key employee while providing the business with key person protection.
- The Split Dollar Loan arrangement provides the key employee with the ownership of a permanent life insurance policy, the business with cost recovery all at a cost to the employee of the interest on the premium paid by the business.
The Advantages of a Split Dollar Plan:
- Allows your business to provide select benefits to key employees.
- Key employee receives valuable life insurance protection and potentially the benefits of owning a permanent life insurance policy.
- Business will either be the owner of the policy (the economic benefit arrangement) or will recover the costs of the arrangement (the loan arrangement).
Your business may enter into an arrangement with your highly compensated or select group of management and provide them with a supplemental retirement arrangement that is tailored to both the business and executive’s needs.
This arrangement is appropriate where the business entity will continue to operate for a long period, at least long enough to pay the benefits promised under the arrangement. Essentially, the business promises to pay a benefit to the executive at some time in the future (often at retirement age).
The Advantages of a Non-Qualified Salary Continuation Arrangement:
- The executive will only pay tax on the benefit when received, allowing the executive to benefit from tax deferred growth.
- The business may informally fund the arrangement with permanent life insurance, providing a source of the funds from both the potential cash value build up and the income tax free death benefit.
- The business will receive a tax deduction on the benefit amounts when they are paid to the executive.
- The business may be highly selective as to who will receive the benefits and how the benefit amounts are defined.