After a dismal 2008 and 2009, businesses are once again implementing life insurance-funded executive compensation plans for non-owner key executives. The double-digit sales increases enjoyed last year by the advisors and home office executives I interviewed for the "year ahead" feature, which begins on p. 21, testify to turnaround.
Not surprisingly, most small and mid-size businesses served by producers are electing an IRC Section 162 executive bonus: cash to pay for a permanent insurance policy on the life of a key executive who selects and owns the product. Typically, the employer funds a single bonus equal to the policy premium; but many firms "gross up" or double the bonus to cover the key employee's income tax liability.
Why do so many small businesses continue to favor bonus plans over alternative executive comp arrangements? For starters, they're simple to set up and maintain: The plans can be established, administered and terminated without IRS approval or government reporting.
Contrast this with regulation of non-qualified deferred compensation plans. Informally funded with cash value life insurance, these plans since 2005 have had to comply with a maze of rules under IRC Section 409A regarding the timing of deferrals and distributions. The setup and administrative requirements can be costly, which explains why generally only mid-size and large businesses adopt the plans.
Also to consider: Because employer-owned cash value policies that fund NQDC plans are carried as an asset on company balance sheets–admittedly a positive for those businesses needing the cash on hand–companies also pay gains on the policies' investment earnings. That may be perfectly acceptable for a largely, publicly held C-corp. But pass-through entities–S-corps., LLC and LLPs–often view such arrangements unfavorably because the taxable gains fall on the individual owners.
That's not the case with executive bonus arrangements, which offer businesses other advantages. For the employer, the premium costs are tax-deductible. If the policy is a variable or VUL contract, the key employee can direct investments in the policy's subaccounts.
Because the policy is owned by the employee (and thus portable) it generally is also protected from claims of the employer's creditors. Plus, the key employee can with withdraw funds or borrow against the policy (up to the amount of the premium paid) tax-free. At retirement, the accumulated cash value may be received as a lump sum or in installments. And in the event of the employee's passing, beneficiaries receive the death benefit proceeds income tax-free.
