Attract, Retain and Reward Key Executives through Non-Qualified Benefits

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1 Attract, Retain and Reward Key s through Non-Qualified Benefits 1

2 The content of this presentation has been prepared for educational purposes only. It is not intended as, and it does not constitute legal advice. It is recommended that anyone who reads this presentation obtains legal advice from their attorney or financial advisor before performing any of the transactions described therein. Banco Popular de Puerto Rico, its subsidiaries and affiliates do not offer tax, legal or accounting advice. If you would like to receive legal, tax or accounting advice, you should consult a professional specialized in these areas. Insurance products and services are offered by Popular Risk Services an Insurance broker duly licensed by the Office of the Commissioner of Insurance of Puerto Rico. Insurance products are not insured by the FDIC, or by other government agencies, are not deposits or obligations and are not guaranteed by the Bank or its subsidiaries or affiliates. Some insurance products may lose value. Popular Risk Services is a subsidiary of Popular and an affiliate of Banco Popular. 2

3 Non Qualified Benefits Plans An alternative for employers to retain and compensate selective executives 3

4 WHAT ARE NONQUALIFIED EXECUTIVE BENEFIT PLANS? Contractual arrangements between an employer and selective executives where the employer promises to pay selective executives a specified benefit at retirement or anytime in the future. Unlike qualified benefit plans, nonqualified plans are usually unfunded and unsecured. There are no underlying assets to settle the benefit obligation, and the executive has no right to the employer's assets beyond those of an unsecured creditor. To provide some comfort to the executive that the promised benefit will be paid, employers often fund the benefit with investments, annuities or cash value life insurance. 4

5 WHY A NONQUALIFIED PLAN? Key Background Facts and Figures: An individual s recommended retirement income should be between 70% and 80% of pre-retirement income. * Social Security benefits only represent a limited portion of your pre-retirement income. As of 2018, this estimate is 40% on average, but only 26% for individuals in the highest SSN taxable income ($128,400)** For Highly Compensated Employees, a qualified retirement plan will provide only a nominal amount of what will be needed for retirement (benefits are capped at certain annual compensation limits: $275,000 for 2018). Life expectancy is increasing. *** Inflation risk reduces purchasing power. Highly-compensated employees are limited by non-highly compensated employees as to the amount they can contribute in a Qualified Savings Plan. * Source: State Farm Bank ** Source: Social Security Administration *** Source: Indexmundi: 79 years is the life expectancy in PR 5

6 WHY A NONQUALIFIED PLAN? EMPLOYER BENEFITS Effective recruiting and retention tool. Employer decides which Key s participate. Bonus payment may generate income tax deduction. IRS or PR Treasury Department approval is not required. Minimal administrative expenses. Coverage and contribution amounts may vary by participant. 6

7 WHY A NONQUALIFIED PLAN? EXECUTIVE BENEFITS Can defer current compensation and taxation. Employee names plan beneficiary. Can include Tax-Free death benefit paid to beneficiary. May have access to values in the event of disability or changes in the control of the Company. Can have Tax-advantaged growth. At retirement, plan values may be a source of supplemental income. 7

8 WHY A NONQUALIFIED PLAN? Manager and Senior, both 45 years of age and expected to work until retirement at age 67; both are making contributions of 10% of gross salary ($15k max) to their company s (d) plan each year. The company matches the deferral at $0.50 on the dollar, up to 6% of salary. This example assumes a 4% return in average. Income Source Manager, age 45 Senior, Age 45 (3.7% Annual Increase) Current Salary Final Salary (Age 67) $75,000 $250,000 $159,873 $532, (d) account value at Age 67 ($100K Beginning Balance) Annual post retirement (d) income (Age 67-90) $724,568 $1,032,385 $48,770 $69,489 Post retirement annual income as a % of final salary 33% 14% In summary, one could state that qualified plans by themselves appear to be inadequate as a retirement planning tool for highly compensated executives. 8

9 DIFFERENCES BETWEEN A NQ AND A QUALIFIED PLAN Taxation for Employee Taxation for Employer NQ Plan Not taxed until money received or deemed paid Not entitled to tax deduction until benefits are actually taxed to the employees Qualified Plan Not taxed until money received Employer is entitled to a deduction at the time contributions are made to the Plan Earnings Retirement Legal and Administrative Requirements May be taxable to employees or the Employer before paid from the Plan No special tax treatment at retirement for employees Minimal and inexpensive Accumulate on a tax deferred basis until paid from the Plan Permit further tax deferral (e.g. rollovers) or preferential tax rates (10%) Burdensome and expensive 9

10 FLEXIBLE PLAN DESIGNS We can provide multiple options to meet the specific needs of the business. Some examples include: Bonus Plans Double Bonus Plans Leveraged Bonus Plans Split Dollar Plans Loan Regime Endorsement Split Dollar Plans Deferred Compensation Plans Deferred Savings Plans- funded from employee contributions SERPs (Supplemental Retirement Plans)- funded entirely by the Employer. 10

11 FUNDING OPTIONS INVESTMENTS ADVANTAGES No Surrender Charges High Liquidity Potential for Higher Investment Returns Flexible Contributions Diversification DISADVANTAGES Values Subject To Market Fluctuations (No Principal Protection) Investment returns subject to tax on capital gains and dividend distributions No Minimum Guaranteed Investment Returns No Death Benefit Generally, No Creditor Protection 11

12 FUNDING OPTIONS ANNUITIES ADVANTAGES Tax Deferral (for Variable Annuities, tax deferral is available only if executive owns the contract) Optional Living Benefits Are Available At An Additional Cost Income for Life Principal Protection Flexible Contributions Diversification Return of Premium Death Benefit DISADVANTAGES Values Subject To Market Fluctuations Contingent Deferred Sales Charges High Annual Fees Generally, No Creditor Protection 12

13 FUNDING OPTIONS CASH VALUE LIFE INSURANCE ADVANTAGES Tax free death benefit to age 121 Insured can designate any beneficiary Living Benefits (Cash Values) grow tax deferred Returns on Cash Values are stable and predictable, increasing in accordance with contractually guaranteed and non guaranteed schedules Cash Values are protected from the claims of creditors (If executive owns the policy) Cash Value growth can be distributed income tax-free, through policy loans Cash Value may be used as collateral Optional riders may provide benefits in case of Disability or to provide for Long Term Care. DISADVANTAGES Low Liquidity In First Years of Policy Low Premium Flexibility in First Years of Policy 13

14 International Medical Coverage for s 14

15 ATTRACT, RETAIN AND REWARD Money talks certainly holds true when analyzing executive retention and attracting new talent. The most important benefit an executive can receive is their compensation. Second to that, and in most cases expected, executives want to know that you are offering a comprehensive major medical plan and retirement savings plan. 15

16 IMPORTANT FACTS For many years, open access policies have been an alternative to offer top s an enhancement to their health program which allows them to receive services in the US. Due to the high cost of health services in the US, the premiums for open access policies in PR increased significantly in the last 5 years. The use of US providers for annual checkups, cancer treatments and other chronic conditions have also increased in PR, especially among CEOs, and senior level s. Underwriting guidelines for most of the local insurance companies limited this benefits to groups with over 100 more employees in PR. The recent migration of local specialists has contributed to the interest of considering US providers for medical services. There are other alternatives to complement local health coverage with open access health coverage for s. 16

17 INTERNATIONAL MEDICAL COVERAGE International health policies are available in the market and are being offered to complement local coverage with comprehensive major medical. Is a great option for top management that travel to the US or Latin-America. The programs works as high deductibles plans. Medical underwriting is required and it can be purchased for individuals or groups over 10 employees. The insured has to reside in PR and have not attained age 75. There is no maximum renewal age. 17

18 BENEFITS This type of plans offer a range of deductibles for members and provides coverage for inpatient care, outpatient care, emergencies, preventive care, plus a pharmacy benefit and more: Worldwide health coverage Access to the best hospitals in the US International Medical Coverage Personal Medical Advisor for Second opinions COB with local health plan 100% coverage 18

19 HOW TO DECIDE WHICH PLAN DESIGN IS RIGHT FOR YOU? 1. Who owns the values in the plan? How is important is having the values protected from the claims of creditors? 2. Does the corporation wants full control, partial control, or no control of values in the plan? 3. Does the business wants to take a tax deduction today for contributions to the plan? Or can the business wait until s separation of employment? 19

20 BUSINESS OWNS VALUES EXECUTIVE OWNS VALUES ACCUMULATION PERIOD Bonus Pays income tax on bonus Pays deductible premium Double Bonus No out of pocket cost Pays double bonus to cover Exec. s tax liability Leveraged Bonus Split Dollar Loan Regime Endorsement Split Dollar Pays loan interest Pays deductible premiums and gives loan to Exec. for taxes due on bonus Pays loan interest Pays non- deductible premiums. Total premiums considered loan to Pays tax on Term Cost of Insurance Pays non- deductible premiums Deferred Compensation No out of pocket cost Pays non- deductible premiums 20

21 BUSINESS HAS PARTIAL CONTROL BUSINESS HAS FULL CONTROL BUSINESS HAS NO CONTROL CONTROL Bonus Controls total cash value and death benefit May place restrictive endorsement on policy cash values Double Bonus Controls total cash value and death benefit May place restrictive endorsement on policy cash values Leveraged Bonus Controls cash values and death benefits in excess of amount loaned by Bus Controls cash values and death benefits up to amount paid/loaned Split Dollar Loan Regime Controls cash values and death benefits in excess of amount loaned by Bus Controls cash values and death benefits up to amount paid/loaned Endorsement Split Dollar Controls death benefit in excess of cash values Controls total cash values and the death benefit up to the cash value of policy Deferred Compensation No Control Controls total cash value and death benefit 21

22 BUSINESS DEDUCTS PREMIUMS IN RETIREMENT/ROLLOUT BUSINESS DEDUCTS PREMIUMS DURING PAYMENT PERIOD RETIREMENT/ROLLOUT Bonus Can use cash values as a source of supplemental retirement income No Cost Double Bonus Can use cash values as a source of supplemental retirement income No Cost Leveraged Bonus Repays loan from cash values. Remaining cash values may be used for retirement No Cost Split Dollar Loan Regime Repays loan from cash values. Remaining cash values may be used for retirement No Cost Endorsement Split Dollar Pays taxes on total cash values. Remaining cash values may be used for retirement Benefit payments are tax deductible for the Deferred Compensation Pays taxes on total cash values. Remaining cash values may be used for retirement Benefit payments are tax deductible for the 22

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