Executive Benefits 101: What, Why, Who, and More

What are executive benefits?

At EBS, we specialize in creating, structuring, implementing, and administrating executive benefit programs. But what exactly are executive benefits?

Executive benefits enable an organization to selectively reward the key employees and executives of a business. Unlike qualified plans, like 401(k) plans, for example, there are no coverage or participation requirements for an executive benefit program. This allows a company to provide rewards and incentives based on an employee-by-employee approach, offering maximum design flexibility.

Executive benefit plans typically focus on protecting executives and their families against death or disability while employed, and on providing sufficient levels of retirement income.

Why offer executive benefits?

We believe executive benefits are a critical component of any corporate benefits strategy.

The COVID-19 pandemic made widespread remote work a reality and effectively created a global talent pool. Businesses can now find top talent anywhere. The downside, though, is that top executives have more opportunities for employment.

Executive benefits can help companies compete and attract key executives who will contribute to company growth and profitability. A well-designed executive benefit program can provide incentives that help retain key executives for the longest possible time.

Executive benefit plans can be structured to provide flexibility in developing benefit compensation strategies, as they can be used to:

  • Provide replacement income at retirement based on total compensation (not limited compensation)
  • Attract, reward, and retain key executives
  • Replace benefits lost due to IRS limits on qualified plans
  • Provide benefits in addition to those under qualified plans
  • Defer compensation to a future date, such as retirement
  • Provide enhanced benefits in the event of an acquisition or other change of control

Who is eligible?

Unlike qualified plans, which must be offered to a non-discriminatory group of employees, a non-qualified plan may be offered to a select group of employees. The Department of Labor (DOL) requires that the plan be designed to cover a select group of management and/or highly-compensated employees.

Certain job titles generally meet this description such as, president, chief executive officer, chief financial officer, senior or executive vice president, general counsel, and treasurer. Other employees may be eligible based on their level of compensation and responsibilities.

The select group can even be quite narrow, for example, President, and effectively cover a single individual.

A key objective of plan design is to stay within the DOL requirement and confine the benefit to a select group of employees. Otherwise, the significant reporting and compliance requirements of ERISA would apply.

Examples of executive benefit programs

Deferred Compensation Plan (DCP)

The IRS limits an employee’s pretax savings contribution in a 401(k) plan to $20,500 per year in 2022, with an additional $6,500 for those age 50 and older. For highly compensated executives, maximizing 401(k) contributions can result in an inadequate accumulation of retirement assets. 1

A deferred compensation plan allows for the deferral of up to 100% of all forms of pay, including base salary, bonus, commissions, and special incentives. Even restricted stock units, a significant component of executive compensation, can be deferred.

Historically, the focus of these plans has been on the deferral of compensation until retirement. But a plan that allows for payouts before retirement can attract the younger executive who is planning for significant pre-retirement expenses like college tuition and second homes.

In addition to an executive’s voluntary contributions, employers can also contribute to an executive’s deferred compensation account. Vesting requirements can be used to enhance executive retention.

Supplemental Retirement Plan (SERP)

Supplemental retirement plans are company funded programs. Some are implemented to enhance benefits provided to all employees under a qualified plan. For example, a company might provide a 50% match in their 401(k) plan on employee contributions of up to 6%. Because the IRS limits the amount of compensation the match can apply to of up to $305,000 in 2022, executives earning over that amount who contribute 6% would be losing out on company match contributions. A 401(k) restoration SERP could provide a vehicle for employee and employer contributions over the IRS compensation limit.1

SERPs can provide benefits beyond those provided under the qualified plan. Enhanced benefits might include:

  • A benefit based on a more generous formula than used in the qualified plan
  • Credit for additional years of service under a defined benefit plan
  • Enhanced retirement benefits for executives who retire early
  • A benefit reflecting compensation excluded under the qualified plan’s salary definition such as bonuses and deferred compensation
  • A defined contribution incentive retirement plan that allows a company to reward top executives based on the performance against specific company benchmarks.

Loan Regime Split Dollar (LRSD)

Split dollar is a form of life insurance ownership under which a company lends the premiums to an executive for a cash value policy at low Applicable Federal Rates (AFR). The loan is secured by the policy and is either paid back at retirement using a portion of the cash value or paid back at death using a portion of the death benefit.

The only cost to the executive is the interest on the loan, which can either be paid annually (or treated as imputed income with a resulting tax cost) or added to the loan. If added to the loan, there is no out-of-pocket cost to the executive.

The insurance policy can provide death benefit protection for the executive while employed. Then, during retirement, the accumulated cash value can be used to supplement retirement income. Structured properly, distributions from the policy can be income tax-free.

LRSD plans can be financially attractive to plan sponsors when compared to other forms of cash compensation because plan funding is ultimately recovered through loan repayment.

Restricted Endorsement Bonus Arrangement (REBA)

Rather than lending premiums to an executive under a LRSD plan, a company can bonus an executive the funds to pay for a cash value life insurance policy that the executive owns. This bonus is deductible to the company and taxable to the executive. The company could choose to gross-up the bonus amount to cover the tax cost on the bonus.

As with a LRSD plan, the insurance policy can provide death benefit protection for the executive while employed. Then, during retirement, the accumulated cash value can be used to supplement retirement income.

To restrict an executive’s early access to policy cash value, the company can place a restrictive endorsement on the policy. This can encourage the executive to remain with the company to receive additional bonuses and the cancellation of the endorsement at a later date.

Disability Insurance (DI)

Most companies provide access to group disability benefits for all employees. However, group plans often cap the benefit paid during disability to 60% of salary. In addition, most have monthly benefit caps of $10,000 or less. The cap on the benefit and the exclusion of all non-salary forms of compensation can challenge an executives’ ability to maintain their lifestyle if they become disabled.

A supplemental disability policy can help cover the difference between what the employee will receive from the employer’s group long-term disability policy and what they need to maintain their lifestyle if they become disabled. Specialty plans are available that can replace base salary and incentive compensation for highly compensated employees. These plans typically do not require medical underwriting and are portable.

Implementing a Plan

EBS has been helping clients develop executive benefit plans for their top talent for over 30 years. Executive benefits are an excellent way for an organization to create personalized retirement benefits for their top talent.

When a client comes to EBS looking for ways to improve their benefits program (or initiate) we use a consultative approach to review your current strategy and company goals and to identify employees that the plan would be offered to. We present a range of alternatives and financial models for each.

Once a plan is placed, we strive to provide expert ongoing administration and technical support to help ensure the plan remains compliant and cost-effective.

1 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits.

Insurance guarantees are based on the claims-paying ability of the issuing company. Neither EBS nor LSF offers tax or legal advice. Always consult your tax professional.

2016 Proposed Section 457(f) Regulations – Planning Opportunities for Non-profit Organizations

INTRODUCTION

In 2007 the IRS has promised future guidance under Section 457(f) for non-profit organizations with respect to compensation planning techniques that were commonly used at that time:

  • Severance pay arrangements
  • Non-compete agreements,
  • Extension of a risk of forfeiture (so-called, “Rolling Risk of Forfeiture”) and,

In June 2016 (after only 9 years), the IRS issued Proposed Section 457(f) Regulations that provide helpful guidance, and even some surprisingly good news. The Regulations are effective for years beginning after the publication of the Final Regulations; however, taxpayers can rely on the Proposed Regulations now.

SEVERANCE PAY EXEMPTION

The Proposed Regulations provide needed clarification, and indicate that a severance pay arrangement is exempt from Section 457(f) if it meets certain requirements:

  • Separation from service must generally be involuntary
  • However, a voluntary separation from service may qualify for exemption if:
    • For “good reason,” as defined in the Regulations
    • Or during a window period
  • The payments must be made by the end of the second year following termination
  • The amount must not exceed 2 times the annualized rate of pay for the prior year:
    • Note 457(f) / 409A difference: There is no limit under the Proposed Section 457(f) rules with respect to the amount of severance pay that is exempt, whereas the limit under Section 409A is 2 times the compensation limit ($550,000 for 2018).

NON-COMPETITION AGREEMENT AS A “SUBSTANTIAL RISK OF FORFEITURE”

Under the Proposed Section 457(f) Regulations, a non-compete agreement may represent a “substantial risk of forfeiture” and defer the timing of taxation if the agreement is:

  • In writing
  • Enforceable under applicable law
  • There is a bona fide interest for the participant and the employer to enter into the agreement
  • And there is compliance with on-going requirements for monitoring by the organization and written verification from the participant

This clarification of the rules creates an opportunity to defer the taxation of compensation beyond separation from service, and provides the employer non-compete protection.

  • Note 457(f) / 409A Difference: This is another case of inconsistency with Section 409A, which does not recognize a non-compete agreement as a “substantial risk of forfeiture.” Therefore, the deferral of compensation after separation from service under Section 457(f) must be coordinated with the Section 409A distribution rules.

VOLUNTARY DEFERRAL OF COMPENSATION

In 2007, the IRS’s position was that it would be irrational for an employee to voluntarily defer compensation that was already earned and vested to a substantive risk of forfeiture and, therefore, it would not recognize elective deferrals.

However, the 2016 Proposed Section 457(f) Regulations provide that the voluntary deferral of compensation will be recognized if the employee has an opportunity to earn a “materially greater” amount of compensation at the end of the vesting / deferral period. More specifically;

  • The deferral election must be made before the beginning of year of service during which the compensation will be earned,
  • The minimum amount of the benefit payable at the end of the vesting / risk of forfeiture period that would meet the “materially greater” test is 125% of the amounts voluntarily deferred, on a present value basis and,
  • The minimum period of extension of the vesting / risk of forfeiture period is 2 years, during which substantive services are provided and/or an enforceable non-compete agreement is in place.

EXTENSION OF THE RISK OF FORFEITURE

The vesting / risk of forfeiture period may be extended using the same 125% test. In addition:

  • The agreement to extend the risk of forfeiture period must be made at least 90 days before the original vesting date and,
  • The period of extension must be at least 2 years.
  • Note 457(f) / 409A difference: If the agreement to extend the risk of forfeiture period is based on a non-compete agreement, the arrangement comply with the subsequent election rules under Section 409A (12 months prior election / 5+ year extension).

IN SUMMARY

The 2016 proposed Section 457(f) regulations provide helpful guidance and a number of planning opportunities; subject to strict compliance with the new rules.

HYPOTHETICAL EXAMPLE

The following example illustrates a one possible planning concept under the Proposed Section 457(f) Regulations:

  • Problem / Issues:
    • A non-profit organization would like to encourage the CEO to:
      • Continue working for 2 years past his normal retirement date,
      • And to enter into a consulting / non-compete arrangement for 2 years after the extended retirement date.
    • The CEO needs additional retirement savings.
  • Possible solution:
    • The CEO agrees to voluntarily defer $100,000 of his $300,000 annual salary for each of the two years of extended full-time employment, and 100% of the $150,000 annual consulting fee paid for the 2-year consulting / non-compete period.
    • Amounts deferred are credited to a deferred compensation account in the name of the CEO as is interest at the 10-year Treasury Bond rate.
    • The Organization promises to credit to the CEO’s account a retention bonus in the amount of $150,000 at the end of the 2-year consulting / non-compete period.
  • Result:
    • The CEO would continue to work full-time for two more years and part-time during a 2-year consulting / non-compete period, during which he would provide substantive consulting services and assist with the transition to the new CEO.
    • The CEO will earn an above market rate of return on the compensation voluntarily deferred to compensate for the voluntarily assumed risk of forfeiture, and add significantly to his retirement savings.

Caveat: This example is intended to illustrate a possible planning concept under the Proposed Section 457(f) Regulations. Any such arrangement must also be compliant with Section 409A, and take into consideration the new Section 4960 21% excise tax on excessive compensation – a subject for a later blog.