Another plan used to attract and retain key executives is the Non-Qualified Supplemental Executive Retirement Plan, which is sometimes referred to as a salary continuation plan. This plan utilizes life insurance to provide benefits to both the employer and the select key executives they wish to attract or retain. It offers executives supplemental retirement income or death benefits and, as stated above, allows the employer to offer an incentive plan to help with recruiting and retaining key executives.
Setting up The Non-Qualified Supplemental Executive Retirement Plan
There will need to be a formal agreement drawn up between the employer and the executive that complies with requirements that are specified in IRC Sec. 409A. Because this is a legal document you will need it drawn up by legal counsel
- The employer purchases and owns a cash value life insurance policy on the life of the executive and will pay the nondeductible policy premiums. The employer is able to use the cash value of the policy as a tax efficient way to accumulate the funds to pay for future retirement benefits for the executive.
- Once the executive retires the employer will pay retirement benefits to the executive. The amount is deductible to the employer and taxable to the executive that has retired.
- If the executive passes away before retirement, the employer may use the generally income tax-free death benefit it receives from the policy to pay out survivors benefits to the executive’s named beneficiaries, which are deductible to the employer and taxable to the beneficiaries. Note that this is different from most beneficiary payouts so make sure you talk with your agent and accountant before going into this type of plan with your employer or key executive
- Any money left over to the employer after paying out the executive’s survivor benefits belongs to the employer as a generally tax-free income for cost recovery.
Why Use Life Insurance to Fund the Plan
As with most of these types of plans, using a life insurance policy to fund them takes the burden off the employer to come up with other means to bonus an executive. The executive benefits because the employer has additional cash from the cash value to fund supplemental income when he/she retires and, if the executive dies before that time, their survivors have income paid out to them as a lump sum; even though it is taxed income. The company is able to offer the plan because the life insurance policy allows it to pay premiums throughout the years and not use resources it needs to operate.
Disadvantages of using life insurance to Fund the Plan
There are always disadvantages that need to be taken into consideration when considering any type of compensation agreement that is funded all or partially by life insurance. Whether you are the company or the executive, always go over the pluses and minuses of the arrangement with your attorney and accountant before agreeing to such an arrangement. Make sure you discuss any other features and benefits with your agent when considering this arrangement.