With the market for managerial talent at a premium, pest control companies need to be creative in offering incentive plans to attract employees. Here is one we’ve seen work with some of our clients and friends.
Providing employer-funded life insurance policies can create a competitive edge and attract employees. Under Section 162(a)(1) of the Internal Revenue Code, an employer can sponsor a bonus plan and deduct the bonus amount (premiums) paid to, or on behalf of employees as an “ordinary and necessary business expense.”
Under the plan, an employer can provide life and/or disability income insurance to key employees using tax-deductible dollars. Each policy is owned by the employee, and is paid through cash bonuses that usually pay the premium, which is included and reported on the employee’s W-2 form. The insurance-funded bonus plan allows the employee to set aside additional funds he or she could access if needed for retirement or other purposes, provide death benefit protection to family members, and establish estate liquidity.
The employee has all the ownership rights of the policy, including the right to name his or her own beneficiary and access the policy’s cash value. The exception is when a Restricted Executive Bonus Arrangement (REBA) is used, which is my preference. REBAs are sometimes also known as Section 162 plans or Controlled Executive Bonus Agreements.
If cash value life insurance is used, a REBA may be incorporated into the plan. The REBA prevents the employee from accessing the policy’s cash values without the consent of the employer.
Employers often use this approach as a device to retain key employees. The employer usually develops a written agreement with each employee that defines specific “qualifying” events that will trigger the release of the employee from the agreement. For example, the REBA may be terminated in the event of the employee’s death, disability or retirement, or after a specified period of time such as 10 years. This technique creates a sort of “golden handcuffs,” and provides incentive to key employees to remain with the company.
The insurance company typically provides a Controlled Executive Bonus Agreement form that spells out the circumstances under which the policy’s cash value may be accessed. The insurance company is not a party to the REBA, however, and typically will only follow instructions it has been given to allow or prohibit access to cash values.
Bonus amounts (premiums paid) are tax-deductible to the business if the bonuses are considered reasonable compensation. The employee will owe income tax on the bonus amount when the bonus is received; that is, premiums are paid. Death benefits generally are received by the employee’s beneficiary free of income tax. Life insurance will be includible in the employee’s estate if the employee retains ownership of the policy.
The beauty of this plan is that upon retirement, the employee can access the policy’s cash value via tax-free loans and withdrawals to supplement his or her retirement income. The plan may make sense for employers looking to attract and retain key employees or provide carve-outs from group-term life insurance programs, particularly for younger key employees in lower tax brackets who likely have insufficient insurance coverage.
Employers may appreciate the relative ease of implementing and administering these plans, whereas employees can benefit from access to cash values if needed for retirement or other purposes, and death benefit protection.
If this interests you, speak to your tax advisor.