Nonqualified Plans:  Baiting the Benefit Hook


Gregory S. DuPont April 13, 2020

Most employers realize competitive salaries are not the only things desired by the best workers. Sought-after employees also expect compensation packages to include valued benefits and this can be a challenge for companies of all sizes.

So what are the options?

A qualified retirement plan is a traditional component of many employee benefit packages. As a business owner, you’re likely to appreciate the advantages: Your contributions are tax deductible and accumulate on a tax-deferred basis. However, these plans can be difficult to administer and contain many regulations restricting employee eligibility, participation, vesting, and employee contributions.

What’s the alternative? Nonqualified plans offer the flexibility to selectively choose whom you’ll cover and how much you’ll contribute for each individual. Many companies use them to supplement or replace their qualified plans. Although there is a wide range of nonqualified plans from which to choose, executive bonus plans and deferred compensation plans are among the most popular.

Executive Bonus Plans

If you’re seeking a plan that provides a current tax deduction, consider the executive bonus plan. This strategy may make sense when your company’s tax bracket exceeds your personal tax bracket. Here’s how it works: You choose which workers you wish to reward with a bonus. The bonus comes in the form of a life insurance policy on the selected employee, and your company pays the premiums.

The simplicity of this approach may be very appealing to you as a business owner. It benefits the selected employees as well, since their families receive additional protection over what your company’s group life insurance plan offers. The employee can also look forward to having access to the policy’s cash value, which can be used to help supplement future college costs or retirement income.

Executive Restrictive Bonus Plans

A twist on the preceding plan is the executive restrictive bonus plan. This plan resembles a regular bonus plan, except that your company retains greater control over the life insurance policy. This is accomplished by attaching a special endorsement that prohibits the employee from surrendering, loaning, or withdrawing the cash value from the policy. Control of this agreement is spelled out in a contract that defines your company’s rights and the vesting terms for the employee. Restrictive bonuses provide an effective means for rewarding key employees—including yourself—while retaining some measure of company control over plan assets.

(Note: Using such restrictions may cause your company to be considered a beneficiary, since you exercise control over the policy and may have access to cash values. This could affect your company’s ability to take a tax deduction for your contributions to the plan. It may be best to discuss this issue with your tax professional.)

Deferred Compensation Plans

With a deferred compensation arrangement, you agree to continue an employee’s salary for a specified period of time after retirement. Although your company’s contribution to the plan is not currently tax deductible, deferrals grow tax free provided your company uses a tax-deferred funding vehicle, such as life insurance. One advantage of a deferred compensation plan is that it gives your company control of the funding vehicle. However, it is up to you to decide whether you’d rather have a current tax deduction or one that’s deferred. This is another issue you may wish to discuss with your tax professional.

When “fishing” for the best workers, the lure of non-qualified plans with their selective benefits can help you bait your benefit hook.