Retaining Top Talent
Oct 02, 2024Retaining Top Talent
by Tom Wall Ph.D., MBA, MSFS, CLU, ChFC
The most valuable asset of a small business is its employees. These employees, due to the small nature of the company, can have outsized impact on the success of the organization. Some have specialized knowledge, trade secrets, or valuable relationships that would cause the company to suffer or fail if lost. Thus, companies have every incentive to think about how they’re attracting and retaining top talent.
One of the creative ways a company can reward its key people is to carve out a small set of people and offer them something additional. Typically, these carve-outs are non-qualified, meaning they don’t have the typical requirements that all employees be included, but at the cost of some present-day tax benefits. In general, the tradeoff is between tax deductions and control.
In the case of non-qualified deferred compensation, the company makes a promise to pay a future benefit, typically in exchange for a certain period of time of service to the firm. For example, an influential VP may be told that she will receive a large bonus after completing 10 years of service. In such a case, the company cannot deduct anything yet because nothing has been given - they must wait until 10 years have passed. But they have total control - if the employee leaves in less than 10 years, they get nothing.
In these plans, the company will often use life insurance as a way to accumulate funds for that future payout. In the above scenario, it would probably make a lot of sense for the firm to purchase key-person coverage on the executive due to their unique value. However, the firm may enter into a split dollar arrangement instead, keeping the cash value for themselves but assigning the death benefit to the employee as a fringe life insurance benefit. In either case, however, no current tax deduction is taken except perhaps for the insignificant cost of insurance in the split dollar case.
The executive bonus strategy (sometimes referred to as 162 Bonus), is where the executive owns the policy and the company pays them a bonus to cover the premium. Since the company has no control over the contract (or the bonus after it’s paid), they can take a current tax deduction. In the case of a business that is closely held or in the family (where there isn’t a flight risk of the employee), this may be more favorable. The company may also choose to pay an additional bonus to cover the tax liability of the executive, referred to as a double bonus.
All of these strategies have unique advantages and tradeoffs, but meeting in the middle can be tough. To do so, some employ the leveraged executive bonus strategy, where the taxes due are loaned to the executive and secured with a collateral assignment against the executive’s policy. Doing this allows for a zero out-of-pocket cost for the executive, a tax deduction of the premium amount for the business, and a bit of control over the plan, since the executive cannot access a collaterally assigned policy without the involvement of the assignee.
In conclusion, never forget to ask your business owner clients if they have any key people in the organization they cannot do without. You might just open one of the biggest cases of your year