Executive compensation packages are as varied as the executives they cover. Packages that supplement and protect retirement assets pack the strongest punch.
Preparing for retirement can be challenging; even more so for executives. Despite higher income, the annual contribution limits of qualified retirement plans leave executives at an economic disadvantage. The maximum allowable contributions may represent a sizable percentage of salary for a rank and file employee, but allow for a very small percentage of an executive’s income.
The employer, however, can overcome the limitations of qualified plans with a carefully constructed executive compensation plan comprised of life and long-term care insurance products to provide both retirement income and asset protection.
There are at least two additional benefits to using insurance to supplement executive compensation.
- First, life insurance offers a unique combination of tax advantages, the policy value growth is tax-deferred (like the tax treatment of the growth of the value of a 401(k)), and unlike 401(k)s or other qualified pension plans, the policy value can be accessed tax-free. Contributions to life insurance are not limited to IRS maximum contribution limitations and life insurance policies do not require an annual minimum distribution as qualified plans do.
- Second, the employer may deduct the premium paid as a benefit expense for both life insurance and long-term care. Life insurance may not require the same SEC disclosures as other forms of compensation the employer may be required to report. Because life insurance and long-term care insurance do not fall under the ERISA umbrella, the employer may offer these perks selectively.
Depending on the compensation objective, life insurance can be used to:
- Provide the executive with additional life insurance via Executive bonus (section 162). With the understanding that a fixed portion of the annual bonus will be used to pay life insurance premium, the employee purchases and owns life insurance on him or herself. As with any bonus, it is taxable to the employee. To reduce the tax implications, the employer may choose to increase the bonus amount sufficiently to pay the additional tax. To sweeten the offer, the life insurance policy may have a specific payment period, 10-pay or 20-pay, making the policy fully paid at the end of the period.
- Fund the future liability of deferred compensation. The employer may own a policy insuring the executive. When deferred compensation becomes payable, the employer accesses the policy value to cover the liability. The company does not have to use company cash flow for the distribution. The employer often chooses to continue the policy and collect the remaining death benefit when the employee dies.
- Pay the premium for a supplemental permanent insurance policy. The executive may access the policy value at will and usually tax-free. Policy values may be used as a supplemental income stream, allowing investments to grow and delaying the need to use investments as retirement income.
While life insurance supplements retirement assets, long-term care insurance protects retirement assets.
Health care costs and long-term care expenses have the greatest potential to decimate retirement assets. Long-term care insurance will protect those assets. Carriers offer significant discounts to participants of employer-sponsored long-term care plans. Many will allow a spouse or partner to enroll for coverage as well. Just sponsoring a long-term care insurance plan makes the coverage more affordable. The employer also has the option to pay for long-term care insurance as part of the compensation package.
The Employee Bonus, Section 162 mentioned earlier, can be used with long-term care insurance. It also may be deductible as an employee benefit expense and is not subject to ERISA rules. Long-term care insurance benefits are not considered income and are therefore not taxable to the executive. A few long-term carriers offer a limited premium payment period. Just as with life insurance, a fully paid long-term care insurance policy relieves the executive of paying policy premiums in retirement.
For more information about executive compensation and our expertise in this arena, read Life Insurance: A workhorse for funding executive benefits. As your full-service employee benefits partner, we can help you design, communicate and administer a plan within the framework of your company’s financial and business strategies. Contact the Higginbotham Life/Executive Benefits team to get started.