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.
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.