Last year was not a particularly good year for presenting executive benefits. Employers were struggling to make payroll, and even key employees were simply trying to hang on to their jobs. This year has seen a significant change in the market.
Key employees are feeling overworked, underappreciated and underpaid and employers know they need to do something about it. As employers start to rebuild their businesses and their fortunes, they are coming to recognize the importance of retaining and rewarding the key employees who kept them afloat during the recession.
The executive benefit market has changed radically following the recession. Other than perhaps on Wall Street, stock options, country club memberships and big bonuses are no longer the way to retain people. Particularly with small- and medium-sized businesses (SMBs), key employees are, like their rank and file counterparts, working to pay tuition, save for retirement and have a contingency plan if something bad happens.
Executive benefits in the SMB market are not a money grab or a greed sale; they are simply a way for employers to help their key employees fill financial gaps. Particularly as a result of the recession, these key employees are returning to the basics: How do I make sure I don't outlive my assets? What can I do to protect my family in the event of a death or disability?
For this group of top performers, the executive bonus concept, funded with life and/or disability income insurance has become the benefit of choice. Executive bonus is a concept long known in the life insurance industry, but in the past was often relegated to being nothing more than a sales technique to sell life insurance.
The idea is simply to bonus the key employee a life insurance policy as a form of compensation. The employer pays the ongoing premium and, in some cases, bonuses the tax on the premium as well. This concept has matured over the years to be a far more sophisticated and flexible executive benefit.
Executive bonus has morphed into allowing both employer and employee contributions and it often involves disability income insurance as well. Where appropriate, underwriting programs such as guaranteed issue or simplified issue may be available to accommodate a large group of highly compensated employees. Executive bonus is now a viable executive benefit for executive pools ranging from one to hundreds of employees.
The market opportunity due to financial and tax conditions
For many business owners and their key employees, the recent recession was a wakeup call. It was a reminder that there won't always be good years and big profits. For key employees the recession exposed financial gaps that call for foundational solutions like funding family needs in the case of death or disability.
For owners of these businesses, they realized they need to form an exit plan, often requiring the active involvement of key employees. And, these plans need to be funded. A perfect storm of financial downturn and demographics cry out for a new look at how to incentivize key employees.
Executive bonus helps fill the financial gaps. As employers start to rebuild in this recovering economy, their first order of attention is often on their executives. The top performers can be offered individual life insurance or disability income insurance in the form of an executive bonus. This helps the executive fill gaps in benefits and it provides a motivation to stay with the company.
Tax benefits are another reason executive bonus fits the bill for so many companies. Many SMBs are S Corps or LLCs. For these pass-through entities, traditional deferred compensation may not work as an executive benefit. The owner objects to the delay incurred in deducting the benefit, and the employee may be concerned with the security of the deferred compensation promise.
Especially with smaller businesses that are S Corps or LLCs, there may be a blurring in distinguishing owners from key employees. If an employee owns more than 2% of the company, for income tax purposes the employee is treated as an owner, and thereby loses the traditional tax benefits of group term life insurance and long-term disability (LTD) programs. These benefits, which can be tax-advantaged for rank and file employees are fully taxable to owner/employees.
In situations like these, executive bonus can be a particularly attractive executive benefit. Rather than just relying on the base benefits group term life and an LTD plan provide, the key employee receives individual life and disability income insurance. Granted the employee is currently taxed on the premium, but they are equally taxable on group term and LTD anyway, and in an environment where income taxes are expected to increase, life and disability income insurance offer the potential for the payout of tax-free benefits.
Making it happen
Utilizing executive bonus as an incentive tool requires understanding by both employer and employee. It is not like a stock option or qualified pension plan where the parties are familiar with the concept. For both life insurance and disability income insurance, the benefit is best explained by graphically demonstrating how the concept works.
Chart 1 below shows a graphic for how a disability income policy can be structured. Chart 2 shows how a life insurance policy works during the accumulation phase and Chart 3 below shows how it works during the distribution phase. These graphics help explain the underlying mechanics of the executive bonus plan without making the concept feel complex.
Compared with other executive benefit plans, an executive bonus plan is simple to adopt. Insurance applications and, if appropriate, a corporate resolution can get the plan going and the employer maintains the plan through ongoing premium payments.
With life insurance, it is important to pay attention to details like proper disclosure and reporting under IRC 101(J). And, if the employer wishes to restrict the executive's access to the policy and its values for a period of time, an employment agreement and restrictive endorsement are necessary. Working with the right financial representative and insurer, all these details can be easily managed.
Small- and medium-sized businesses are starting to rebuild, and their key employees provide the foundation. An executive bonus plan funded with life and disability income insurance is an ideal solution for retaining and rewarding these key employees.
Steve Parrish, JD*, CLU, ChFC, RHU, is national advanced solutions consultant with the Principal Financial Group.
Timothy M. Dardis, LUTCF, is senior financial services representative with the Principal Financial Group and president of Dardis Financial Strategies, LLC. Dardis is currently president of NAIFA, South Dakota.
*JD is an educational degree and the holder does not provide legal services on behalf of the companies of the Principal Financial Group.
While this communication may be used to promote or market a transaction or an idea that is discussed, it is intended to provide general information about the subject matter covered and is provided with the understanding that the author is not rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.