Cultivating a Deeper Understanding of Executive Benefits
Executive benefits represent a pivotal tool for organizations seeking to recognize and incentivize their vital employees and executives. These benefits differ from qualified plans such as 401(k) programs, as they don’t come with specific coverage or participation prerequisites. This unique characteristic empowers companies to take an individualized approach, tailoring rewards and incentives on a per-employee basis, thereby granting the utmost flexibility in design.
In practice, executive benefit plans primarily revolve around safeguarding executives and their families in the event of death or disability during their employment. Simultaneously, they serve as a crucial pillar in ensuring executives have access to ample retirement income. Let’s delve deeper into the world of executive benefits and what makes them an invaluable component of your organizational strategy.
Why Invest in Executive Benefits?
The advent of the COVID-19 pandemic ushered in a new era of widespread remote work, effectively expanding the global talent pool. This transformation means that businesses now have the opportunity to tap into top-tier talent from virtually anywhere. However, this shift also brings with it an intriguing challenge: top executives now possess a wealth of employment options.
Executive benefits serve as a strategic solution for companies aiming to remain competitive in this dynamic talent landscape. They play a crucial role in not only attracting but also retaining key executives who are instrumental in driving a company’s growth and overall profitability. A well-structured executive benefit program serves as a powerful tool, offering incentives that encourage these key leaders to stay committed to the organization for the long term.
These executive benefit plans are highly adaptable, allowing companies to craft compensation strategies that meet specific needs. They can be harnessed to:
- Provide retirement income based on an executive’s total compensation (beyond the limitations of qualified plans).
- Attract, acknowledge, and retain key executives.
- Replace benefits that may be curtailed due to IRS restrictions on qualified plans.
- Offer supplementary benefits in addition to those provided by qualified plans.
- Allow for the deferral of compensation to a future date, such as retirement.
- Deliver enhanced benefits in the event of an acquisition or other significant changes in corporate control.
In essence, executive benefits are a strategic imperative for companies aiming to secure, reward, and retain the top talent needed to thrive in today’s dynamic and competitive business landscape.
Eligibility Criteria: Who Qualifies?
In contrast to qualified plans, which must be accessible to a broad, non-discriminatory group of employees, non-qualified plans offer the flexibility of targeting a more exclusive subset of your workforce. To align with Department of Labor (“DOL”) regulations, these plans must be structured to encompass a specific category of management and/or high-earning employees.
Certain job titles naturally fall into this category, including positions like president, chief executive officer, chief financial officer, senior or executive vice president, general counsel, and treasurer. Alternatively, eligibility can also extend to employees whose compensation and responsibilities warrant inclusion.
In fact, the scope of this select group can be quite narrow, to the extent of, for example, covering only the President, effectively serving the needs of a single individual.
A central objective in plan design is to adhere to the DOL’s requirements, which mandate that the benefit remains exclusive to this select group of employees. Deviating from this framework would trigger substantial reporting and compliance obligations under ERISA.
Illustrations of Executive Benefit Programs
Deferred Compensation Plan (“DCP”)
In 2022, the IRS imposed a cap of $20,500 on an employee’s annual pretax savings contribution to 401(k) plans, with an additional $6,500 allowance for those aged 50 and above. However, for highly compensated executives, maximizing contributions within this framework may lead to an inadequate accumulation of retirement assets.
This is where a deferred compensation plan comes into play. It permits the deferral of up to 100% of various forms of compensation, encompassing base salary, bonuses, commissions, and special incentives. Notably, even components of executive compensation such as restricted stock units can be included in the deferral.
Traditionally, these plans have emphasized deferring compensation until retirement. Nevertheless, a more flexible approach allows for payouts before retirement, appealing to younger executives who are planning for substantial pre-retirement expenses like college tuition and second homes.
In addition to an executive’s voluntary contributions, employers also have the option to make contributions to an executive’s deferred compensation account. Vesting requirements can be strategically employed to further incentivize executive retention.
Supplemental Executive Retirement Plan (“SERP”)
Supplemental executive retirement plans represent company-sponsored initiatives, often introduced to bolster the benefits available to all employees within a qualified plan. For instance, a company might offer a generous 50% match in its 401(k) program for employee contributions up to 6% of their income. However, due to IRS limitations restricting the portion of compensation eligible for this match (up to $305,000 in 2022), executives earning above this threshold who contribute 6% could miss out on valuable company match contributions. In this scenario, a SERP can be offered, enabling contributions from both participating executives and employers beyond the IRS compensation limit.
SERPs offer a range of benefits that extend beyond the scope of qualified plans. These enhanced advantages might encompass:
- Benefits calculated using a more generous formula than that of the qualified plan.
- Credit for additional years of service under a defined benefit plan.
- Augmented retirement benefits for executives opting for early retirement.
- Benefits reflecting compensation elements excluded under the salary definition of qualified plans, such as bonuses and deferred compensation.
- A defined contribution incentive retirement plan that empowers companies to reward top executives based on performance against specific company benchmarks.
Loan Regime Split Dollar (“LRSD”)
LRSD represents a unique life insurance ownership arrangement where a company extends a loan to an executive, covering the premiums for a cash value policy at highly favorable Applicable Federal Rates (“AFR”).
The loan is secured by the policy and can be repaid in one of two ways: either from a portion of the policy’s cash value upon retirement or from a portion of the death benefit. For the executive, the sole financial obligation is the interest on the loan. This interest can be handled in two ways: it can be paid annually, potentially incurring some tax liability, or it can be added to the loan balance, eliminating any immediate out-of-pocket costs for the executive.
This insurance policy serves a dual purpose. While the executive is employed, it offers valuable death benefit protection. Later, during retirement, the accumulated cash value can be accessed to enhance retirement income. When structured correctly, distributions from the policy can be received tax-free.
For plan sponsors, LRSD plans can be an appealing financial option when compared to other forms of cash compensation because the plan’s funding is eventually recovered through loan repayment, making it a cost-effective solution.
Restricted Endorsement Bonus Arrangement (“REBA”)
In lieu of advancing premiums through a LRSD plan, a company has the option to award an executive a bonus that the executive then utilizes to secure ownership of a cash value life insurance policy. This bonus is considered a deductible expense for the company and is subject to taxation for the executive. The company may also choose to augment the bonus amount to offset the tax liability incurred by the executive.
Much like an LRSD plan, this insurance policy can deliver essential death benefit protection during the executive’s employment. Subsequently, as retirement approaches, the accumulated cash value can be harnessed to bolster retirement income.
To restrict an executive’s early access to the policy’s cash value, the company has the option to impose a restrictive endorsement on the policy. This serves as an incentive for the executive to remain affiliated with the company, with the prospect of receiving additional bonuses and the removal of the endorsement at a later, specified date.
Disability Insurance (“DI”)
While many companies offer group disability benefits to all employees, these group plans often come with limitations. They typically cap the benefit paid during a disability at 50% to 60% of the individual’s salary, with most also imposing monthly benefit caps of $10,000 or less. These constraints, including the exclusion of non-salary compensation, can pose challenges for executives aiming to sustain their lifestyle should they experience a disability.
Supplemental disability insurance can bridge the gap between what an employee would receive from the employer’s group long-term disability policy and what they need to maintain their quality of life in the event of disability. Specialized plans are accessible to replace not only base salary but also incentive compensation for highly compensated employees. Remarkably, these plans often don’t necessitate medical underwriting and offer portability for added flexibility.
Wisterm is at the forefront of crafting executive benefit plans that cater to the unique needs of top-tier talent. Executive benefits offer organizations a powerful avenue to design tailored retirement solutions for their most valued individuals.
When a client turns to Wisterm for enhancements to their existing benefits program or the initiation of a new one, we adopt a consultative approach. Our process involves a comprehensive review of your current strategies and company objectives, coupled with an analysis to pinpoint the employees who will be offered the plan. We then present an array of alternatives and financial models, ensuring a well-informed decision-making process.
Once a plan is put into action, we will continue to deliver expert ongoing administration and technical support. This support ensures the plan’s continued compliance and cost-effectiveness, providing peace of mind for both the organization and its top talent.