Help small business owners recruit and retain key employees
by Jeff BarkerMr. Barker serves as Senior Vice President, Brokerage Distribution and Independent Wholesaling, Life Insurance,
AIG Financial Distributors (AIGFD). He can be reached at [email protected].
Small business owners may need help recruiting and retaining valuable employees. An executive bonus arrangement using an index universal life (IUL) insurance policy allows employers to provide key employees with individual life insurance, supplementing any group term life plans in place. The employer can freely choose the employee(s) it wishes to benefit and vary the benefit among the participating employees. Furthermore, the IRS imposes no burdensome tax reporting requirements.
Why IUL? Actually, almost any type of life insurance policy can be used in an executive bonus arrangement. However, selecting a product with cash value growth potential combined with preferred policy loans can be an attractive option for supplemental income and death benefit coverage.1
The focus in this article is on IUL key employee coverage because these policies are designed to provide cash value growth potential through index-linked accrued interest – and may offer increased accumulation than traditional universal life policies. IUL products also are designed to help protect policy owners against the ramifications of market volatility.
How Does It Work?
The employee applies for and owns an IUL insurance policy on his or her life and names a personal beneficiary. The employer pays an annual bonus to the employee, either in cash or indirectly as a premium on the permanent life insurance policy.The result is employer-provided, employee-owned life insurance that offers death benefit protection for income replacement, wealth transfer, or estate planning. Employers can offer it to key employees for significant contributions to the company’s bottom line. (The arrangement is generally not recommended for S corporation owners or partners, since those businesses are not separate tax-paying entities.)
What Are the Tax Consequences?
The employer reports the bonus to the employee and the IRS. Some arrangements provide for an additional cash bonus to offset anticipated payroll and income taxes. This may result in a zero net cost to employees.
Since the annual premium payment or bonus is taxed to the employee, it is generally deductible by the employer provided the employee’s total compensation is “reasonable.” (Keep in mind that all tax claims made in this article are based on current tax law and tell clients to consult a tax advisor when considering their own situation.) If compensation is judged unreasonably high by the IRS, the excess compensation is not deductible by the employer and, like other compensation, is taxed to the employee.
As policy owner, the employee has full access to cash values. The accumulating tax-deferred values may exceed the employee’s tax liability after a few years and can be used to cover those costs if the employee takes a loan or a partial surrender. The employee can also leave the cash value in the policy for emergencies or to supplement future retirement income.
What Are the Benefits?
An executive bonus arrangement funded by an IUL product helps employers provide executives and other key employees with employer-financed, personal life insurance. It is straightforward to implement and administer, with few restrictions or reporting requirements. The employer can tailor each policy with a face amount designed to effectively encourage the selected employee to remain with the company.
For the employee, the arrangement provides additional life insurance protection funded with employer dollars. Cash values that accumulate and grow on a tax-deferred basis in the IUL insurance policy are available for potential emergencies or to supplement future retirement income.
Death benefits paid from the policy to the employee’s chosen beneficiary typically are income-tax-free. In addition, because the IUL insurance policy is owned by the employee and not the business, it is portable should the employee leave the organization.
What’s the Result?
Executive bonus arrangements funded by IUL products provide a tax-favored benefit to key people on a selective basis, giving recipients more life insurance protection, along with the potential for supplemental retirement income and potential long-term cash value accumulation. Employees appreciate knowing that the company values them, which may increase the firm’s ability to retain valuable, productive contributors to the bottom line.
To help ensure understanding, let’s break down what we’ve reviewed. Stay tuned for that hypothetical example of an executive bonus plan in action.
An executive bonus arrangement is an employee benefit in which the employer agrees to either:
- pay premiums on personal life insurance coverage for a selected employee or employees, or
- provide a yearly cash bonus that the employee uses to pay the premiums on personal life insurance.
- The employer creates an employee benefit that rewards specific individuals, such as company executives or other valuable employees.
- The employee enjoys favorable recognition, added life insurance protection, and the potential for increased cash value accumulation that may be used as retirement income.
- The employer spells out the terms of the arrangement in a written agreement.
- The employee applies for and owns an IUL insurance policy on his or her life.
- The employer pays the annual policy premium or provides a yearly cash bonus, which the employee uses to pay the premium.
- The employer may deduct the annual premium payment or cash bonus as long as the insured employee’s total compensation is deemed reasonable by the IRS.
- Excess or unreasonable compensation is not deductible by the employer and, like other compensation, is included in the employee’s gross income.
- The policy’s cash value belongs to the employee and can be used by the employee for emergencies or to supplement income after retirement.
When the employee dies, the beneficiary typically receives the IUL insurance policy proceeds free of federal income tax.
A Hypothetical Example
Consider the following example, which is presented for illustrative purposes only.
Alan owns a thriving engineering business and depends on the president, Wayne (age 45), to keep the business running smoothly. Alan would like to reward Wayne for his efforts and, at the same time, encourage him to continue working until his retirement. Alan also wants this cost to be tax-deductible to the company. After consulting with his financial professional, Alan establishes an executive bonus plan for Wayne.
Under the agreement, a $500,000 IUL insurance policy is purchased. The flexible features of the specific solution selected allow the policy to be structured with a dial-able death benefit guarantee out to age 100. The product also features a guaranteed account value enhancement of 0.75 percent beginning in the sixth policy year.
- The business pays the insurance premium as an executive bonus, which is tax-deductible as reasonable compensation to the company.
- The premiums, $9,700, are paid for 20 years with company cash bonuses.
- Additional bonuses are made to Wayne to cover any tax liabilities.
Optionality in Action
Wayne’s IUL insurance policy offers an illustrated $25,000 per year of tax-free income at retirement lasting 20 years. He also has current (non-guaranteed) coverage that can last his entire life. Guaranteed coverage ends at his retirement.2 Costs are tax-deductible by Alan’s company.3, 4
- Upon Wayne’s retirement, the policy is his with no further premium requirements.
- Wayne is the owner of the policy and can name his own beneficiaries.
- If Wayne leaves the company before age 65, he can take the policy with him and make the required premium payments himself. This extra benefit gives Wayne an incentive to remain with the firm until retirement age. And, as the policy owner, Wayne will have access to the cash value in the policy should he need it.
The Bottom Line
Executive bonus arrangements can provide a simple, tax-favored way to recruit, reward and retain valued employees on a selective basis. Employees enjoy additional life insurance protection and access to cash values that can be used for additional retirement income.
With carrier-provided, online resources on IUL insurance and executive bonus arrangements, it’s as easy to learn more about this strategy as it is to help implement it. And when you can leverage smart products to help small business owners recruit and retain key people, you’re better positioned than ever to recruit and retain clients. ◊
1. Policy loans and partial withdrawals will reduce the life insurance death benefit and cash value and could reduce the duration of coverage. Partial withdrawals may be taxed as regular earnings. The policy owner should consult a tax advisor to determine the effect of these proportions.
2. For the purpose of easing the explanation, all numbers have been rounded. The numbers in the solution were based on an illustration dated 04/16/18 for a 45-year-old male, preferred non-tobacco with premiums paid until age 65. The IUL policy showed the increasing death benefit option until age 65 and all distributions were illustrated using tax-free loans. Policy loans will reduce the life insurance death benefit and cash value and could reduce the duration of coverage. Policy owners should consult a tax advisor to determine the effect of these proportions. The IUL policy illustrated assumed the use of the Max Accumulator+ Core Cap Account (utilizing S&P 500® Index) at a 6% crediting rate. Please refer to a Basic Illustration. Certain features and riders are optional and subject to specific terms, limitations and restrictions. Please refer to the policy for details.
3. This information is general in nature, may be subject to change, and does not constitute legal, tax or accounting advice from any company, its employees, financial professionals or other representatives. Applicable laws and regulations are complex and subject to change. Any tax statements in this material are not intended to suggest the avoidance of U.S. federal, state or local tax penalties. For advice concerning your individual circumstances, consult a professional attorney, tax advisor or accountant.
4. Internal Revenue Code Section 162.
The S&P 500® Index is a product of S&P Dow Jones Indices LLC (“SPDJI”), and has been licensed for use by AGL and US Life. S&P 500 is a registered trademark of Standard & Poor’s Financial Services LLC (“S&P”) and this trademark has been licensed for use by SPDJI and sublicensed for certain purposes by AGL and US Life. AGL and US Life’s IUL products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index.
The information contained in this document is general in nature and intended for educational purposes only and is not a comprehensive analysis of the topic presented. The information may be subject to change and should be verified for accuracy and reliability (e.g., federal income tax statutes, rulings, etc. that may have changed since publication) and may be subject to differing
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AIG is the marketing name for the worldwide property-casualty, life and retirement, and general insurance operations of American International Group, Inc. For additional information, please visit our website at www.aig.com. All products and services are written or provided by subsidiaries or affiliates of American International Group, Inc. Products or services may not be available in all countries, and coverage is subject to actual policy language. Non-insurance products and services may be provided by independent third parties. Certain property-casualty coverages may be provided by a surplus lines insurer. Surplus lines insurers do not generally participate in state guaranty funds, and insureds are therefore not protected by such funds.
Policies issued by: American General Life Insurance Company (AGL), Policy Form Numbers: 15646, ICC15-15646, 15646-5, 16760, ICC16-16760, 16760-5; Rider Form Numbers: 15602, ICC15-15602,15603, ICC15-15603, 15604, ICC15-15604, 15600, ICC15-15600, 82012, 82012-CA, 82410, 88390, 14002, 14002-5, ICC14-14002, 14306, 14306-5, 07620, 15997, ICC15-15997, 15996, 15996-5, 15994, ICC15-15994, 15271, ICC15-15271, 15274, ICC15-15274, 15272, ICC15-15272, 15273, ICC15-15273, 13600-5, ICC13-13600-5, ICC15-15992, ICC16-16110, 15972. Issuing company AGL is responsible for financial obligations of insurance products and is a member of American International Group, Inc. (AIG). AGL does not solicit business in the state of New York. Products may not be available in all states and product features may vary by state.
Guarantees are backed by the claims-paying ability of AGL. They are not backed by the broker-dealer and/or insurance agency from which the policy is purchased or any affiliates of those entities and none makes any representation or guarantees regarding the claims-paying ability of AGL.
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