Executive benefits: Beyond COLI and split dollar

Today’s employers can better reward, and retain, key employees with benefits that are immediate and personal.

In my practice in Silicon Valley, we focus primarily on working with high-end, closely held service businesses.

This means we are working with companies whose primary product is the work or advice given by the company’s employees. Each of our clients relies on the talent of their employees for their success, and within every company, there are always key employees who are absolutely critical to the success of that business.

With this in mind, we seek to find both meaningful and unique ways to reward these employees. This increases the employees’ satisfaction with their employers, which increases productivity and retention as well as serves a defensive function, in that the employee is less likely to leave and take clients with him or her. It also sets up the future option to discuss transition planning between the business owner and the key employee.

All discussions about executive benefits start with one question: Who are the key people and what can we do to make them feel unique and appreciated?

More than deferred compensation

When most insurance agents think about executive benefits, they think about deferred compensation. Although we do bump into an occasional bank-owned life insurance (BOLI) or corporate-owned life insurance (COLI) opportunity (which we refer to the local expert), those types of cases are less common than other types of executive benefits we write. We do discuss restricted bonus and split dollar, but most employees would prefer something a little more immediate. They’re not looking for an unsecured promise of a benefit well into the future, especially from a small employer. So what else can be done?

Although it may seem silly, the simple act of doing something special for somebody, whether it is a complex split dollar case or buying a new desk chair, will have a positive impact. Employees want to know their contributions are appreciated, and they appreciate when other people acknowledge them. This opens up all sorts of possibilities to provide meaningful benefits to an employee.

Business owners will often know what the specific needs are for a key person. Maybe he or she is trying to purchase a home, fund college tuition or purchase additional insurance for the family. But if a business owner doesn’t know, it never hurts for you, as the advisor, to ask the employee what the employer might be able to do to help him. You can set up the conversation by saying the employer would like to recognize the employee’s contributions to the company and wondered if there was something the employer could do to help the employee. Sometimes it’s something as simple as leveraging the corporation’s relationships with financial advisors, bankers, lenders or other professionals to help the key employee. Again, the act of trying to help an employee can create the goodwill we are striving for in an executive benefits plan.

The benefits discussed in this article are funded with employer dollars that are paid to the employee as ordinary income.* The money allocated to pay for a benefit plus the employee’s other compensation must be “reasonable compensation” to be deductible by the employer. So as long as we use ordinary income as our funding mechanism for the benefits, an employer is typically not going to violate a discrimination test. This is a matter for the client’s tax advisor however.

Even though the mechanism for benefit funding is ordinary compensation, if properly explained, it will not be viewed as salary. This is very important because, from a behavioral economics perspective, people typically value what money does — the benefit — more than they value the money itself.

Making benefits meaningful

People generally care about the same fundamental things: providing for their families, saving for retirement and putting their kids through college. Anything an employer can do to facilitate the accomplishment of those goals will be viewed favorably by the key employee. (Much has been written about supplemental retirement plans, so I will not use this article to discuss supplemental retirement plans.)

We all know people like life insurance, but they don’t like having to pay for it. Here is an opportunity for an employer to pay for it for a key person. It is tax deductible to the employer as compensation to the employee (as long as the total compensation is “reasonable”). And even though it is taxable to the employee, it is still a great benefit. Most employees are paying the premium and the tax on the premium for their life insurance. The employee in the above example is just paying the tax on the premium.

We can use the same funding scenario for supplemental disability insurance. When premium is paid with after-tax dollars the benefit is tax free. Another option would be a properly funded wage continuation plan where the premium would be tax deductible to the employer and not taxable to the employee. In cases where the premium is not taxed to the employee, the benefits received during a disability are taxable.

An employer might want to offer an employee with young children access to a Section 529 plan. This could be set up individually through the advisor. Again, an employer could increase an employee’s cash compensation (as long as the total compensation is “reasonable”) to fund the plan. Even though it would be taxable to the key employee, who wouldn’t appreciate this? Currently, the key employee has to fund the contribution and the tax on the contribution. Under the scenario above, the employee just pays the tax on the contribution.

There are a number of ways you can help a key employee feel special and provide a meaningful benefit to him or her, and it all starts with finding out what’s important to that person. As financial professionals, we are in a unique position to help facilitate both the conversation and provide the solutions to help our clients in meaningful ways

*It should be noted any conversation about the tax impact to the client or employee should include their respective tax advisors.

By Bradford L. Elman, CLU from the November 1, 2012 issue of Life Insurance Selling • Bradford L. Elman, CLU, is an insurance agent of the Northwestern Mutual Life Insurance Company (NM) in Milwaukee and a registered representative of Northwestern Mutual Investment Services.

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