Executive Benefit Concepts Contents The Reverse Discrimination of Qualified Retirement Plans Executive Bonus Plan in Action Insured Death Benefit Only Plan in Action Business Split-Dollar Life Plan in Action Split-Dollar Life Plan Premium Variations Group Carve-Out Plan in Action Insured Disability Salary Continuation Plan in Action Deferred Compensation Plan in Action VSA 5B.04 ed. 01-16 VSA, LP The information, general principles and conclusions presented in this report are subject to local, state and federal laws and regulations, court cases and any revisions of same. While every care has been taken in the preparation of this report, neither VSA, L.P. nor The National Underwriter is engaged in providing legal, accounting, financial or other professional services. This report should not be used as a substitute for the professional advice of an attorney, accountant, or other qualified professional. Selective Executive Retirement Plan in Action
The Reverse Discrimination of Qualified Retirement Plans Did You Know That... Qualified Retirement Plans Tend to Discriminate AGAINST the Highly Compensated? The restrictions placed on qualified retirement plans strictly limit the size of the benefits that can be accrued for highly-compensated employees. When compared to the benefits provided to lower-paid employees, these limitations can produce a "reverse discrimination" effect that results in qualified retirement plans replacing an inadequate percentage of an owner's or key executive's pre-retirement income. Reverse Discrimination in Action... The benefits from or contributions to each type of qualified retirement plan are limited or "capped." Eligible compensation that can be considered in applying these benefit or contribution limitations is capped at $265,000 in 2016 (as adjusted for inflation). There is, however, a solution to the inadequacy of qualified retirement plan benefits for owners and key employees... a selective executive benefit plan! Page 2 of 14
Executive Bonus Plan in Action Here's how an executive bonus plan could work to reward and retain your key employees... Business 1 Tax-Deductible Life Premiums 2 Life Policies Insured: Key employee Owner: Key Employee Beneficiary: Named by Key Employee 4 Income Tax-Free Death Benefit Selected Key Employees Employee s Personal Beneficiary 3 Income Tax on Bonus IRS 1. The business agrees to pay the tax-deductible premiums for life insurance policies applied for by selected key employees. 2. Each of the selected key employees owns the policy on his or her life and names a personal beneficiary for the death benefit. While alive, the key employee controls the policy's cash value and is entitled to any policy dividends paid. 3. The cost to the key employee is the income tax due on the premiums paid by the business as a bonus. 4. At the key employee's death, his or her personal beneficiary receives the death benefit free of income tax. Page 3 of 14
Insured Death Benefit Only Plan in Action Here's how an insured death benefit only plan could work to reward and retain your key employees today... 1 Salary Continuation Agreement Corporation 2 Nondeductible Life Premiums 3 Life Policy Insured: Selected Key Employee Owner: Corporation Beneficiary: Corporation Key Employee 1. The corporation enters into a salary continuation agreement with each selected key employee. The agreement specifies the conditions that must be met for salary continuation payments to begin, as well as the amount, frequency and duration of those payments. 2. After satisfying the notice and consent requirements for employer-owned life insurance contracts, the corporation purchases sufficient insurance on the key employee's life to fund the after-tax cost of promised benefits and, if desired, to recover premium costs. 3. The life insurance policy is owned by the corporation, which pays the premiums and is named beneficiary. Page 4 of 14
Insured Death Benefit Only Plan in Action Here's how an insured death benefit only plan could work at a key employee's death... 5 Tax-Deductible Salary Continuation Payments Corporation 4 Death Benefit Received Free of Regular Income Tax Deceased Key Employee s Beneficiaries 4. While the premium payments for life insurance to fund a death benefit only plan are not tax deductible, the death benefit is received by the corporation free of regular income tax (assuming the requirements for employer-owned life insurance are met), but may have corporate alternative minimum tax implications. 5. The corporation uses the death benefit to make the promised salary continuation payments to the key employee's beneficiaries. The payments are tax deductible by the corporation and are taxable as ordinary income to the beneficiaries. Page 5 of 14
Business Split-Dollar Life Plan in Action Here's how a split-dollar life insurance plan could work today... Business 1 Split-Dollar Agreement Key Employee Employer s Share of Premiums 2 Employee s Share of Premiums (if any) 4 Any Income Tax Due IRS 3 Life Policy Collateral Assignment Insured: Key Employee Owner: Key Employee Beneficiary: Named by Employee Assignee: Business OR Endorsement Insured: Key Employee Owner: Business Beneficiary: 1. Business for Total of Its Premiums 2. Employee s Beneficiary for Balance (by policy endorsement) 1. The business enters into a split-dollar agreement with each selected employee. The agreement spells out the rights and responsibilities of each party. 2. Based on the premium sharing arrangement, the business and employee each contribute a portion of the premium payments. 3. The ownership and beneficiary arrangements of the life insurance policy are determined by selection of the collateral assignment or endorsement method. 4. The employee may have to pay income tax on the economic benefit received (economic benefit tax regime) or on imputed interest on the employer's premium "loans" (loan tax regime). Page 6 of 14
Business Split-Dollar Life Plan in Action Here's how a split-dollar life insurance plan could work at the employee's death or policy surrender... 5 At Death 6 At Policy Surrender Proceeds Equal to Total Premiums Paid Balance of Death Benefit Return of Total Premiums Paid Balance of Cash Surrender Value (if any) Business Key Employee s Beneficiary Business Key Employee 5. At the employee's death, the business is usually entitled to receive from the death benefit the total of the premiums it has paid, with the employee's beneficiary receiving the balance of the death benefit, generally on an income-tax-free basis. In an endorsement split-dollar plan, the employee must have either paid for the cost of the current life insurance protection or taken the value of the current life insurance protection into account as an economic benefit in order for his/her beneficiary to receive death proceeds free of income tax. Otherwise, the death proceeds are considered payable from the business to the employee's beneficiary and are taxable as income to the beneficiary. 6. If the policy is surrendered prior to the employee's death, the business is usually entitled to receive from the cash surrender value the total of the premiums it has paid, and the employee receives the balance, if any. Page 7 of 14
Split-Dollar Life Plan Premium Variations In order to overcome the problem of the employee generally having to pay a large portion of the premiums in the early years, a number of premium sharing variations have been developed, including: Employer Pay All Split-Dollar The employer pays the entire premium. Depending on policy ownership, the employee either reports as income the value of the economic benefits received (economic benefit tax regime), or the difference between market-rate interest and the actual interest paid by the employee, if any (loan tax regime). Level Outlay Split-Dollar * The employee's premium contribution is a level amount for a specified period of time, with the employer paying the balance of the premium. Economic Benefit Split-Dollar (Endorsement Plan Only) * The employee pays the portion of the premium equal to that year's reportable economic benefit and the employer pays the balance. This approach eliminates the employee's out-of-pocket cost for the tax on the economic benefit. Bonus Split-Dollar (Endorsement Plan Only) * The employer bonuses the annual economic benefit to the employee. The employee then uses the bonus to pay the portion of the premium equal to that year's reportable economic benefit and the employer pays the balance of the premium. Assuming overall compensation is reasonable, the employer can deduct the bonused amount, which the employee must include in income. Another alternative is for the employer to bonus both the economic benefit and the tax on the bonus, resulting in no out-of-pocket cost to the employee. Bonus Split-Dollar (Collateral Assignment Plan Only) The employer bonuses to the employee an amount equal to the employee's tax liability on the market-rate interest imputed to the outstanding premium "loans." The employee then uses the bonus to pay his/her tax liability. Assuming overall compensation is reasonable, the employer can deduct the bonused amount, which the employee must include in income. Another alternative is for the employer to bonus both the tax liability on the imputed interest and the tax on the bonus, resulting in no out-of-pocket cost to the employee, assuming the employer is paying the full premium. * Important Note: Any premiums contributed to an endorsement split-dollar plan (economic benefit tax regime) by the employee are considered income to the employer. Page 8 of 14
Group Carve-Out Plan in Action Here's how a group carve-out plan could work to selectively reward and retain your key employees... BEFORE THE GROUP CARVE-OUT... In this example, the key employee has $200,000 of group term life insurance, $150,000 of which is taxed to the employee at Table I rates. $200,000 Group Term AFTER THE GROUP CARVE-OUT... The employee's group term life insurance is capped at $50,000, on which there is no imputed income. $50,000 Group Term The other $150,000 is provided by an individual cash value life insurance policy funded by the selected plan design option. $150,000 Individual Cash Value Life Policy Page 9 of 14
Insured Disability Salary Continuation Plan in Action Here's how an insured disability salary continuation plan could work to protect your income and that of your key employees... Business 2 Disability Income Premiums 1 Salary Continuation Agreement Plan Participant 3 Disability Benefits 1. The business implements a salary continuation plan, which specifies who will be covered, the conditions that must be met for disability benefits to begin, and the amount, frequency and duration of those benefits. 2. The business purchases sufficient disability income insurance on each plan participant to provide the promised benefit. Alternatively, the business and plan participant can share the premium payments. 3. Disability benefits are paid by the insurance company to plan participants who become disabled, as defined in the policy. Page 10 of 14
Deferred Compensation Plan in Action Here's how a deferred compensation plan could work for your corporation and selected key executives today... 1 Deferred Compensation Agreement Corporation 2 Nondeductible Life Premiums 3 Life Policy Insured: Selected Key Executive Owner: Corporation Beneficiary: Corporation Key Executive 1. The corporation enters into a deferred compensation agreement with each selected key executive. The agreement spells out the benefits to be provided if the executive fulfills certain conditions, such as remaining with the corporation until retirement. 2. After satisfying the notice and consent requirements for employer-owned life insurance contracts, the corporation purchases sufficient insurance on the key executive s life to fund the after-tax cost of promised benefits and, if desired, to recover its nondeductible premium costs. 3. The life insurance policy is owned by the corporation, which pays the premiums and is named beneficiary. Page 11 of 14
Deferred Compensation Plan in Action Here's how promised benefits could be paid from a deferred compensation plan informally funded with life insurance... 6 Income Tax-Free Death Benefit At Executive s Retirement or Disability Corporation At Executive s Death Prior to Retirement 5 Tax-Deductible Retirement or Disability Benefits 4 Tax-Deductible Survivor Benefits Key Executive Key Executive s Family Income Tax 7 IRS Income Tax 4. If the key executive dies prior to retirement, the death benefit is received free of regular income tax by the corporation (assuming the requirements for employer-owned life insurance contracts are satisfied). The corporation can then use the income tax-free death benefit to pay the promised tax-deductible survivor benefits to the key executive s family. 5. If the key executive becomes disabled prior to retirement or remains actively employed until retirement, the corporation pays the promised tax-deductible disability or retirement benefit from current cash flow, from loans or withdrawals from the policy s cash value, or from a combination of the two (withdrawals and loans will reduce the policy s death benefit and cash value available for use). 6. By maintaining the policy until the key executive s death, the corporation ultimately receives the income tax-free death benefit to recover its costs. 7. Benefits received by the executive or the executive s family are taxable as received. Page 12 of 14
Selective Executive Retirement Plan in Action Here's how a Selective Executive Retirement Plan could work for your corporation and selected key executives today... 1 Salary Continuation Agreement Corporation 2 Nondeductible Life Premiums 3 Life Policy Insured: Selected Key Executive Owner: Corporation Beneficiary: Corporation Key Executive 1. The corporation enters into a salary continuation agreement with each selected key executive. The agreement spells out benefits to be provided if the executive fulfills certain conditions, such as remaining with corporation until retirement. 2. After satisfying the notice and consent requirements for employer-owned life insurance contracts, the corporation purchases sufficient insurance on the key executive s life to fund the after-tax cost of promised benefits and, if desired, to recover its nondeductible premium costs. 3. The life insurance policy is owned by corporation, which pays the premiums and is named beneficiary. Page 13 of 14
Selective Executive Retirement Plan in Action Here's how promised benefits could be paid from a Selective Executive Retirement Plan informally funded with life insurance... 6 Income Tax-Free Death Benefit At Executive s Retirement Corporation At Executive s Death Prior to Retirement 5 Tax-Deductible Retirement Benefits 4 Tax-Deductible Survivor Benefits Key Executive Key Executive s Family Income Tax 7 IRS Income Tax 4. If the key executive dies prior to retirement, the death benefit is received free of regular income tax by the corporation (assuming the requirements for employer-owned life insurance contracts are satisfied). The corporation can then use the income tax-free death benefit to pay the promised tax-deductible survivor benefits to the key executive s family. 5. If the key executive remains actively employed until retirement, the corporation pays the promised tax-deductible retirement benefit from current cash flow, from loans or withdrawals from the policy s cash value, or from a combination of the two (withdrawals and loans will reduce the policy s death benefit and cash value available for use). 6. By maintaining the policy until the key executive s death, the corporation ultimately receives the income tax-free death benefit to recover its costs. 7. Benefits received by the executive or the executive s family are taxable as received. Page 14 of 14