Dual Executive Reward: Positioning Executive Benefits Between Two Boundaries

by LP Green, II

The ability to provide an effective executive benefit, one that serves to recruit, reward and retain a key employee, has become increasingly complex due to a myriad of rules and regulations that have blanketed the industry over the last twenty years.

Executive Benefits Currently

To fulfill their purpose of providing tax deferred retirement income to a select group of executives, nonqualified plans are designed to circumvent many of the restrictions imposed by the Employee Retirement Income Security Act (ERISA). These ERISA restrictions include minimum participation and vesting rules, funding rules and the fiduciary responsibility rules and trust requirement. Nonqualified plans, commonly referred to as “top-hat” plans, allow a business owner to avoid these ERISA requirements if the plan is not funded and only available to a select group of management or highly compensated employees.

Traditional Nonqualified Deferred Compensation

The two most common types of nonqualified deferred compensation are salary deferral and supplemental plan. When deferred these amounts are held by the employer, with some type of earnings accrued, for the benefit of the employee. The payout itself can then be made after a selected period of time. When paid, the benefits become taxable income to the employee and tax deductible to the company.

Executive Bonus

Executive bonus plans, also known as Section 162 Bonus Plans, provide a way for a key employee to purchase life insurance using employer dollars. Generally, the employer pays the premium, which is tax deductible to the company. The employee reports the premium payment as a bonus and is taxable income.

A Different Alternative: Dual Executive Reward

As it becomes increasingly difficult to provide meaningful ways to reward and retain top talent while conforming to government oversight, business owners may want to consider a Dual Executive Reward arrangement. This is an alternative that provides a tangible benefit to key employees, is easier and less costly to administer than a qualified plan or traditional nonqualified deferred compensation plan and complies with current regulations.

Dual Executive Reward:

  • Provides a key employee with a lump-sum bonus after a selected service period
  • Enables the company to informally fund this benefit over time using life insurance
  • Provides the employee with death benefit coverage if they should pass away during the service period
  • Uses a single company-owned permanent life insurance policy using two separate agreements

How does the Dual Executive Reward work?

An agreement is entered between the employer and key employee, where the employer promises to pay the employee a specified bonus upon completion of a specified service period. At the same time, the employer and employee enter into a separate non-equity endorsement split dollar agreement, which allows the employee to obtain life insurance coverage that’s paid for by the employer. While the employee must pay annual income tax on the economic benefit attributable to the death benefit, this arrangement provides the employee with life insurance protection at a lower out-of-pocket cost than a policy purchased on their own. If the employee should die before the end of the service period, the two beneficiaries of the policy, the company and the employee’s loved ones, share the income tax-free death benefit. The award to the employee at the end of the service period is based on the projected cash values of the insurance policy. It is critical that the life insurance policy funding the Dual Executive Reward arrangement has enough accumulated cash value to meet the lump sum obligation at the time it is due to the employee.

Structured properly, a Dual Executive Reward arrangement is a cost-effective way to retain many of the positive attributes of traditional plans, providing a quantifiable incentive for the company’s most talented employees. Professionals who practice in the field of executive benefits should consider this arrangement as a potential compromise between two executive benefit boundaries.

Contributor: Christopher M. Pirtle, LUTCF, Peake Financial Wealth Management

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