ployer typically ties the double bonuses to the
continued future employment of the executive.
By requesting an agreement to repay the bonus
in the event a key executive does not fulfill
the employment contract, the employer can
protect against funding a DBP and then having
the key executive quit shortly afterward.
The appeal of a Section 162 DBP is its
simplicity and deductibility. Because the participant is paying taxes on the bonus, the plan
operates outside the rules and regulations that
apply to traditional NQDc, particularly the
Jobs creation Act rules.
The primary drawback of the Section 162
DBP is the cash flow cost to the employer. Because the employer must gross up the bonus
to cover taxes, the plan is expensive and inefficient from a tax perspective. For this reason,
many employers historically have preferred to establish traditional NQDc arrangements if they offer a plan at all. Passage of
the Jobs creation Acts spurred companies to give the Section
162 DBP another look.
• Section 162 plan with life income strategy: The “life
income strategy” was was created to fill the void in the NQDc
world following enactment of the Jobs creation Act in 2004.
In the life income strategy approach, the employer still
makes two outlays, with the initial bonus payment made directly
to the executive, just as in the DBP. The executive is still liable
for income taxes on that first bonus, but instead of looking to
the employer to cover those taxes, the executive borrows the
funds needed under a pre-arranged agreement with the insurance carrier.
The employer’s second bonus — much smaller than the
DBP — covers only the interest on that borrowed money. Typically, this second bonus is tied to an employment agreement
between the employer and the key employee. The loan is a
non-recourse loan to the executive, secured with a life insurance policy that will replay the loan upon the executive’s death.
This is why a life insurance policy is used in order to utilize the
death benefit account while allowing the cash value account
to accumulate with full-value dollars, free from income taxes,
to provide a retirement income to the executive.
Thus, the life income strategy is essentially an individually owned executive benefits program that’s funded with
high-quality universal life insurance where a portion of the
premium is funded through a loan made internally by the insurance company.
High-income
exec-utives will
find it almost
impossible to fund
an adequate level
of retirement
income through
qualified pension
plans alone.
NQDc plans because it
isn’t subject to Dc plan
regulations or the restrictions of the Jobs creation
Act. consequently, it
allows an employer to
maintain a flexible and
selective fringe benefit
for a key executive without the administrative
burden and long-term
liability of a traditional
plan. Most importantly,
under current guidelines,
contributions to an LIS arrangement are deductible
as wages for corporations,
and substantially reduce
the overall cash flow cost.
