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executive compensation: section 162 executive bonus and loan based split dollar
Justin L. Smith,
Field Marketing Sales Director
ADV 1491
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disclosuresThis seminar is for informational purposes only. The speakers and presenters appearing at this
seminar are solely responsible for the content of their presentations and may not necessarily
represent the opinions of Ameritas Life Insurance Corp. (Ameritas Life), or any of its affiliates. Neither
Ameritas Life nor any of their representatives are in the business of giving tax, legal, or accounting
advice. Attendees should consult with their own accounting, tax, or legal professionals to determine
action appropriate for their unique situation.
This information is provided by Ameritas®, which is a marketing name for subsidiaries of Ameritas
Mutual Holding Company, including, but not limited to, Ameritas Life Insurance Corp., Ameritas Life
Insurance Corp. of New York and Ameritas Investment Corp., member FINRA/SIPC. Ameritas Life
Insurance Corp. is not licensed in New York. Each company is solely responsible for its own financial
condition and contractual obligations. For more information about Ameritas®, visit ameritas.com.
Ameritas® and the bison design are registered service marks of Ameritas Life Insurance Corp.
Fulfilling
life® is a registered service mark of Ameritas Holding Company.
©2014 Ameritas Mutual Holding Company
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executive bonus and beyond
executive compensation – the executive bonus plan
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the importance of our people
“Take away my people, but
leave my factories, and
soon grass will grow on
the factory floors. Take
away my factories, but
leave my people, and soon
we will have a new and
better factory.”
--Andrew Carnegie
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discussion – three main themes
Agenda
•Section 162 bonus plans
•Company benefits and
taxation
•Executive benefits and
taxation
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defined
Executive bonus
•A company financed program for
“select” employees – financing is via
a compensation bonus to employee
•Select employee acquires a life
insurance policy with company
bonus
•Satisfies the company’s purpose of
providing a valuable benefit for the
employee and his/her family
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bonus structure
The company bonus – types
•Single bonus – will cover premiums: the
bonus is compensation income for the
employee – sent directly to insurance
company
•A “second” or “double” bonus will mitigate
the income tax due on bonus #1
•Bonus can be “restricted”
•Company deducts bonus payments as
compensation income
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policy ownership
The policy
•Is owned 100% by employee
•Employee designates beneficiaries
•Death benefits paid to
beneficiaries are income tax free
•Valuable retirement supplement for
employee
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plan operation
How does the plan operate?
•Company “selects” employee
•Company agrees to finance premiums
•Executive utilizes bonus to pay premiums
•Executive recognizes bonus as taxable
income
•Company “grosses-up” tax?
•Company deducts bonus as compensation
•Employee owns policy
• Retirement supplement
• Income tax free death benefit
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company benefits
• Assist valued employees with their
financial planning
• No IRS approval needed
• No administrative fees
• Company can choose employee
participants
• Excellent retention tool
• Bonus payments are compensation
to employee and therefore
deductible if “reasonable”
compensation
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employee benefits
• Employee acquires a valuable
life insurance policy at very little
cost – policy is portable
• Company sends bonus directly
to insurance company
• Cash values can be used to
supplement retirement
• Death benefits are received
income tax free by beneficiaries
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in summary
• Executive bonus arrangements• Ease of implementation/administration
• Company benefits• Provide valuable financial planning benefits• Select employees• Current tax deduction
• Executive benefits• Low cost insurance• Death benefit income tax free• Supplemental retirement funds
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next steps
• Determine type of executive bonus plan -- single, double,
restricted
• Select employee participants
• Determine bonus amounts
• Notify valued employees of plan
• Verify compensation will be characterized as
“reasonable”
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LRCASD - split dollar
executive compensation – loan regime collateral assignment split
dollar
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selective benefits – supplements retirement
The regime – loan
•Why? Supplemental retirement
benefits can be delivered through
loan regime split dollar
•The company loans premiums to
the executive
•The executive owns the policy and
pays the premium
•Executive must repay the interest
and loans
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discussion – three main themes
Agenda
•Loan regime collateral assignment
split dollar plan – minority
shareholders (no restrictions)
•Executive benefits and taxation
•Company benefits and taxation
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how does loan based split dollar (LBSD) work?
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how does LBSD work?
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policy types for LBSD
• LBSD or “Loan Based Split Dollar” • Goal: Supplemental retirement income
• Policy types – which one?• One that has the potential to build cash value rapidly
• Policy design – low face• Desire to build cash value – no MEC’s• Face should meet executives family needs
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steps to make it work
1. Executive purchases an insurance policy
2. Business loans premiums to executive
3. Executive executes note and collaterally assigns policy to
business
4. Executive pays premiums with loan proceeds
5. Executive pays loan interest (when)
6. Executive retires loan and business releases assignment
7. Executive – access cash values to supplement retirement
8. Executive – at death, policy death benefits to family
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a closer look at loans
• Loans are repayable • At specified time• Upon demand
• If the note “specifies a repayment date” = term loan• If no repayment date and payable at death = term loan
measured by executives life expectancy
• Term loan categories• Short – maximum of 3 years• Mid – between 3 years and no more than 9 years • Long – more than 9 years
• Notes with no repayment date = demand note
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practical loan issues
Loans must be documented• This is required for EVERY loan made to the
executive• In other words, for EVERY loan, a NEW note is
required• Corporations – corporate RESOLUTION
required • Policy – don’t forget a COLLATERAL
ASSIGNMENT form
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accounting for loans
• In most business insurance cases – premiums are “annual”
• Each “premium” is therefore a new loan – requiring a new note
• For each premium – determine: • Should the “new loan” be a demand or term loan?
• Practical consideration:
• Demand loans can be POOLED – and even renegotiated to term loans
• Cannot pool term loans• Must stand on its own until its term ends – then renegotiate
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loans – example
Pooled Demand Loans
Term #12.2%
Term #22.35%
Term #33.1%
Demand #3
Demand #4
Demand #5
Demand #2
Demand #1
Standing on their own until the “term” ends
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loan interest
An excerpt from The Insmark illustration
If the loan interest paid on each loan is equal to or greater than the Applicable Federal Rate established under IRC Sections 7872(f)(2)(A) and 1274(d), then no additional loan interestwill be imputed to the executive.
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loans -- example
Term #1 Short
Term #2 Mid
Term #3 Long
0-3 years .36%
3+ - 9 years 1.89%
9+ years 3.09%
Loans should be for at least the amountsshown, depending on “Term”
AFR – August 2014
Blended Annual Applicable Federal Rate -- .31% for 2014
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strategy – three fold
The “Switch”
Growth
Reduced Employee
Costs
Death Benefits
The “Payout”
Supplemental Retirement
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strategy part 1 – low cost
Reduced Employee
Costs
Death Benefits
Recommendation: Begin with Economic Benefit Regime
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why economic benefit regime?
• Taxable on “economic benefit” of insurance MAY be lower
than loan interest
• Executive feels no impact of “interest rate volatility”
• Executive is not personally liable to repay any premiums
– if structured as endorsement split dollar (company
owned)
The Switch
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strategy part II – growth
• Occurs BEFORE cash value exceeds premiums paid
• “Old split dollar” agreements terminated
• Company and executive create a loan arrangement
• If it was an Economic Benefit Regime then policy must
be transferred to the executive
• Company and executive execute a note for TOTAL
premiums paid to date –now treated as “loan”
• Don’t forget the collateral assignment for the loans
The “Switch”
Growth
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strategy part III – distributions
The big question – how to
“REPAY” the loans?
•Other personal assets
•Other business funds
•Be careful – loan repayment and
additional compensation MUST
remain INDEPENDENT
Reduced Employee
Costs
Death Benefits
The “Switch”
Growth
The “Payout”
Supplemental Retirement
Let’s look at “Rollout”
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the rollout
• Could take loans from the policy to repay the company –
remainder belongs to executive
• Does the executive have a SERP – use the taxable dollars to
repay the loan • Could use loans from policy to pay the tax on SERP payments
• Has executive engaged in bracket management over the
years?• Assets available at 0% or 15% tax to repay loans• Executive could take loans from policy to pay tax of 0-15%
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summary
• When the company wants to build significant
supplemental retirement benefits for the executive and
receive all sums “loaned” in repayment, LBSD is your key
• Cost of acquisition can be minimized by beginning with an
endorsement split dollar – then switching to loan regime
split dollar
• Executive can rollout of plan with many options, thereby
reducing tax burden and maximizing supplemental tax-
free retirement funds
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what’s next
• Find a company interested in providing executive
compensation benefits to their executives in the most
cost effective way
• Find a company with an “existing” executive
compensation plan and ask, “When was your last
executive compensation check-up?”
• Call your wholesaler to schedule a meeting or reach out
to Advanced Markets and discuss the case with them