Competition for key talent is heating up and employers are searching for strategies to address the “four Rs” – recruiting, retaining, rewarding and retiring key employees. While many employers offer a qualified savings plan, the 2021 contribution limit of $19,500 for those under the age of 50 and $26,000 for those age 50 and older does not permit a highly compensated employee to save as much as they would like. At the other end of the spectrum, employers offer non-qualified deferred compensation plans and split-dollar arrangements, but both of these do not offer the employer a current tax deduction.
A Restricted Executive Bonus Arrangement (REBA) can meet the employer’s goals of attracting employees, retaining them for long period of time, rewarding them for good performance, retiring them with adequate savings and receiving a current tax deduction. Under a REBA, key executives purchase a cash value life insurance policy on his or her life and use bonus payments from their employer to make premium payments.
Structurally, the policy is ‘maximum funded’ and only the minimum amount of death benefit required to meet the definition of life insurance is purchased. By establishing the policy as a non-Modified Endowment Contract (non-MEC), the employee can later access the policy’s cash value in the form of tax-free withdrawals and loans. The loans remain tax-free as long as the policy stays in-force during the insured’s lifetime. Essentially, the policy funding is the same as for a Life Insurance Retirement Plan (LIRP).
The employer may also choose to ‘gross up’ the bonus amount to cover the taxes on the bonus so the employee has no out-of-pocket cost. This is referred to as a ‘double bonus’, though the amount is usually just a small amount in comparison to the bonus.
In order to retain and incentivize the REBA participant, the employer puts a restrictive endorsement in place. This endorsement restricts the employee’s access to cash value for a period of time, encouraging them to meet performance measures to obtain additional bonuses and to stay with the employer until at least any restrictions on the REBA are gone. Employers will typically apply either a cliff vesting or a percentage by year vesting as a part of the restriction.
When cliff vesting is applied, the bonuses are 0% vested until a specific year, at which time they become 100% vested. If the employee leaves before then, the bonus must be repaid to the employer. A plan that calls for the employee to have no vesting for five years would be an example of cliff vesting.
When percentage by year vesting is applied, a set percentage of the total bonuses paid vests each year. If the employee leaves the company, the unvested portion of the bonus would need to be repaid.
A REBA is documented in a plan agreement signed by both the employer and employer. The document spells out the rights of both parties, including an explanation of the restriction to cash values agreed upon. A REBA should be considered a long-term planning approach because of the need to build up cash value in the policy. As the required amount of death benefit comes down after the definition of life insurance is met (usually 7 to 12 years), the cash value growth does not have the drag on performance of high insurance costs.
Premium payments made by the employer are generally believed to be compensation to the employee under IRC §61. Therefore, subject to “reasonable compensation” limitations described in IRC §162, an amount equal to the total bonus paid will be income taxable to the employee, and the employer will receive a corresponding deduction.
A REBA can be a simple, tax-deductible option for an employer to use to recruit, retain, reward and retire key employees who matter the most to a business. Under a REBA, an employer can provide an incentive for the key employees to remain working for the business, while the employees enjoy tax-free access to future income and low-cost death benefit protection.
REBA Advantages for the Employer
A benefit to recruit, retain, reward and retire key employees
A current income tax deduction
Easy to implement and administer
Employer remains in control through the length of employment
No IRS approval needed for implementation or termination
Allows employer to pick and choose participants
REBA Advantages for the Employee
No income-tax cost when a double bonus is applied
Designed to meet individual benefit and contribution needs
Ability to access the cash value of the policy via tax-free withdrawals and loans
Individually owned policy is safe from the creditors of the employer
The employee may keep the policy if he or she changes the employer
Whatever remains from the policy’s death benefit is received by the policy’s beneficiary income tax-free
Since its inception, Life Insurance Strategies Group has solely focused on the individual high net worth life insurance market. We do not sell products. This allows us to offer unbiased, pragmatic advice.
If Life Insurance Strategies Group can help you make decisions regarding life insurance and your business, reach out to us at www.lifeinsurancestrategiesgroup.com.
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