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Business owners today are faced with increased competition for

talented key executives.

Unfortunately, traditional compensation strategies fail:

Salary increases and bonuses have short-lived impact on long-

term job satisfaction and loyalty to the corporation; and

Tax law changes have made it more difficult to single out and

reward talented executives through the use of tax-qualified

retirement plans.

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To help an executive compensation arrangement achieve the employer's goals effectively, it is important that the design account for both the employer's needs and those of the executives it wishes to reward.

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While the Internal Revenue Code and ERISA provide limitations on designing executive compensation strategies, companies can maximize their efforts to retain and reward their best executives by selecting a plan type that best matches executive compensation goals.

This selection process involves an examination of the various characteristics or “design variables” associated with each plan type.

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There are seven basic plan designs for non-qualified executive benefits that your

company may want to consider:

1. NQDC or SERP Arrangements;

2. Split Dollar Loan Arrangements;

3. NQDC /Split Dollar Combo Arrangements;

4. Endorsement Split Dollar Arrangements;

5. Survivor Income DBO Arrangements;

6. Executive Bonus (§ 162) Arrangements; or

7. Restricted Executive Bonus Arrangements (REBAs)

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To take the greatest advantage of the flexibility available in nonqualified plan

designs, a wide variety of factors should be considered during the planning

process. The following is a list of some of the factors that should be considered:

Deferral of Income Taxation. Sometimes the primary reason for implementing

a nonqualified plan is to allow executives to defer taxation on income until the

money is actually needed (i.e., not pay taxes on a benefit until retirement).

While some nonqualified plans (such as SERPs and NQDC arrangements) allow

for income tax deferral, this is not true for all nonqualified plans.

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Current Tax Deduction. Some nonqualified plans (such as bonus

arrangements and REBAs) allow employers to take a current deduction for

payments made to the executive. Such arrangements, however, do not

typically allow the executive to defer recognition of income. Consequently,

parties to nonqualified plans often must decide whether executive tax

deferral or employer deductions are more important to the plan design.

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Retirement Income. Nonqualified plans may provide retirement benefits, death

benefits, welfare benefits, or any combination thereof. This question asks

whether retirement income is of high importance to accomplishing the desired

objectives for implementing the nonqualified plan.

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Protection From Employer’s Creditors. Nonqualified plans must be “un-

funded” if the arrangement is to provide income tax-deferral for the executive.

This means that any assets used to help finance obligations under such

arrangements must be part of the employer’s general assets and that the

executive can have no claim on the funding asset greater than that of a general

creditor. Consequently, nonqualified plans which provide tax-deferral often

expose the funding asset to claims of creditors of the employer.

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“Golden Handcuffs.” One of the primary reasons for employers to implement

nonqualified plans is to provide incentives that will help retain key executives.

Where a benefit is tied directly to a requirement that the executive continue

working for the employer, the arrangement is said to have “Golden Handcuffs.”

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Income Tax-Free Retirement Distributions. While some nonqualified plans

provide for tax-deferral, others provide the possibility of taking tax-free

distributions during retirement. This factor asks the parties to consider whether

tax-free distributions in retirement may be as important, or more important, than

the opportunity for tax-deferral during employment.

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Flexibility. Due to the rules imposed under IRC § 409A, some nonqualified

plans must be essentially fixed from inception. SERPs and NQDC

arrangements must have a pre-determined payment schedule to comply with §

409A. Other nonqualified plans (such as split-dollar, bonus arrangements and

REBAs) allow the executive to flexibly determine whether or when to take

distributions.

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Income Tax-Free Death Benefits. While death proceeds from a life insurance

policy are generally received income tax-free, this is not necessarily true for

death benefits paid pursuant to nonqualified plans. Some nonqualified plans

(such as split-dollar arrangements, bonus arrangements, and REBAs) provide

beneficiaries with income tax-free death benefits while beneficiaries from other

nonqualified plans (such as SERPs or NQDC arrangements) must pay income

taxes on death benefits received (as income in respect of a decedent or “IRD”).

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Cost Recovery. Some employers will not consider making contributions to

nonqualified plans unless there is a way to get some or all of their money back.

Nonqualified plans such as SERPs, NQDC arrangements, and split-dollar

arrangements can be designed so that a portion of the death benefit from the life

insurance policy used to fund the arrangement can be paid to the employer thus

allowing for cost recovery.

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ERISA or “Top Hat” Limitations. ERISA imposes reporting requirements and

places limitations on who can participate in some nonqualified plans such as

SERPs and NQDC arrangements. Other nonqualified plans, such as bonus

arrangements and REBAs, are outside the scope of ERISA.

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Ease of Administration. Nonqualified plans such as SERPs and NQDC

arrangements can require significant plan administration (maybe even

requiring a third-party administrator). Other nonqualified plans, such as split-

dollar arrangements, bonus arrangements, and REBAs, require little or no

plan administration.

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Balance Sheet Impact. For some employers, the impact of a proposed

nonqualified plan on the company’s balance sheet can be a very important

factor in choosing a plan design. While most nonqualified plans (such as

SERPs, NQDC arrangements, bonus arrangements, and REBAs) have a

neutral impact or no impact on the company’s balance sheet, any

arrangement which provides a promise of post-retirement death benefits will

have a (potentially significant) negative impact on a company’s balance

sheet.

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NQDC & SERP Arrangements are nonqualified arrangements where an

employer promises to pay an executive a future benefit. The benefit may be

structured as a single payment or as a series of payments which typically

commence at the executive’s retirement or upon the executive’s death.

Nonqualified deferred compensation (NQDC or defined contribution)

arrangements promise a benefit based on the amount of money contributed to

the arrangement and an assumed growth rate. Supplemental executive

retirement plans (SERPs or defined benefits) promise a benefit amount based

on years of service, reaching retirement age, or at death. In both types of

arrangements, the executive does not pay income taxes until the benefits are

paid out. Businesses will typically purchase a life insurance policy to provide

funds that will be needed to pay the promised benefits. These plans are subject

to the requirements of IRC § 409A .

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1. The business and the executive agree that supplemental retirement income

is an important component of the executive’s total compensation package.

The parties execute a NQDC or SERP agreement that spells out the benefits

promised to the executive and upon what conditions such benefits will be

paid.

2. The business acquires a cash value life insurance policy on the executive’s

life.

3. The business pays premiums on the life insurance policy. These premium

payments are not deductible to the business, nor are they treated as income

to the executive (so long as the arrangement complies with § 409A).

4. At the executive’s retirement, the business may use the policy’s cash values

to pay the benefit promised to the executive. Alternatively, in the event of a

premature death, the death proceeds of the policy can be used to provide

benefits to the executive’s survivors.

• The retirement payments will be treated as ordinary income to the executive

and as a deductible expense to the company (assuming the benefit is within

reasonable compensation limits);

• Death benefits paid to the executive’s survivors are also treated as ordinary

income (I.R.D.) and as a deductible expense to the company (assuming the

benefit is within reasonable compensation limits). Alternately, a split-dollar

arrangement can be used for the death benefits (see split-dollar slides below

for discussion of tax treatment)

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5. At the executive’s death, the death benefit proceeds can be used by the

business to recover the costs of the arrangement.

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A split dollar loan is an arrangement where an employer helps to provide an executive with retirement and death benefits by providing the funding for the ownership of a life insurance policy. The employer pays premiums on a life insurance policy owned by the executive, but retains a collateral assignment interest in the policy equal to the sum of the premiums it has advanced. The premium advances are treated by the IRS as loans and the executive pays taxes on the interest that is “imputed” on the loans.

When the Executive retires, the Employer may either recover its premiums from the Executive or forgive the loans and treat the premiums as a taxable bonus to the Executive.

The policy values are then available to the Executive as a source of supplemental retirement income.

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1. The company identifies a need to retain and reward a key executive. The

company and the executive agree that personal life insurance protection and

the related cash value accumulations are important components of the

executive’s overall compensation package. The parties execute a split dollar

agreement setting forth their rights and obligations.

2. The executive acquires a cash value life insurance policy on his or her life

and executes a collateral assignment with Voya indicating the policy rights

reserved to the employer.

3. The company makes premium payments on the policy.

• The premium payments are treated as advances or below-market loans from

the company to the executive;

• Each year, the executive is taxed under IRC § 7872 on the amount of interest

imputed by the IRS on the sum of premiums that have been advanced;

• The company retains a collateral assignment interest in the policy equal to

the sum of premiums advanced.

4. At retirement, the company either recovers its premiums from the executive

or releases its interest in premium advances by treating the split dollar

agreement termination as a retirement bonus to the executive.

• If the company chooses to release its interest in the premiums advanced,

this amount is treated as a taxable bonus to the executive and as a

deductible expense to the company (assuming the bonus is within

reasonable compensation limits);

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• After termination of the split dollar loan arrangement, the policy’s cash values

are available to supplement retirement income through loans and

withdrawals. Loans and withdrawals may generate an income tax liability,

reduce available cash value, reduce death benefit or cause the policy to lapse

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Read from slide.

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An endorsement split dollar plan in an arrangement where an employer allocates

to an executive the right to designate the beneficiary of a portion of the death

benefits of a life insurance policy owned and paid for by the employer. The

employer pays all of the premiums on the life insurance policy and uses a policy

endorsement form to endorse an identified portion of the death benefit to the

executive. The executive is taxed annually on the “economic benefit” of having

life insurance coverage and the death benefits, when paid, are income tax-free

to the executive’s designated beneficiaries.

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1. The Employer and the Executive enter into a Split Dollar agreement where

the employer gives the Executive the right to designate the beneficiary for a

portion of the death benefit of a life insurance policy owned by the Employer.

2. The Employer purchases a policy insuring Executive’s life. The Employer

pays all premiums on the policy. The Executive is taxed annually on the

economic benefit or term costs associated with the death benefit coverage.

3. Upon the Executive’s death, the insurance company pays a death benefit to

the Executive’s beneficiaries. These benefits are received by the

beneficiaries income tax-free. Any additional death benefit under the policy

may be used by the Employer to recover some or all of the costs of

providing the benefit.

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A survivor income death benefit only (“survivor income DBO”) plan is a promise

by an employer to provide a benefit to a participant’s designated beneficiary in

the event of the participant's death. The promise is unfunded for ERISA

purposes in the sense that the benefit cannot be tied to a certain asset. Typically,

however, an employer will purchase a life insurance policy to provide funds when

needed. The employer pays all costs of the insurance and holds the policy as

part of its general assets with no interest in the policy endorsed or assigned to

the employee. While the executive pays no income taxes during participation in

the plan, the benefits paid from a survivor income DBO arrangement are fully

taxable as income in respect of a decedent (I.R.D.) to the participant’s

beneficiaries.

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1. The Employer and the Executive enter into a Survivor Income DBO

agreement where the employer promises to pay a benefit to Executive’s

survivors upon death. The Executive makes a written designation of

beneficiaries for the benefit.

2. The Employer purchases a policy insuring Executive’s life. The Employer

pays all premiums on the policy. The Executive is not taxed on these

premium payments.

3. Upon Executive’s death, the insurance company pays the policy death

benefit to the Employer.

4. The Employer pays the promised benefit to Executive’s designated

beneficiaries. This benefit is taxed as income in respect of a decedent

(IRD). The Employer may use any surplus death benefit to recover its costs

for the plan.

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Read from slide.

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An Executive Bonus ( or § 162) Plan is an arrangement where an employer makes premium payments on a cash value life insurance policy owned by an executive. While the executive must recognize the premium payments as ordinary income, the executive can use the policy as a source of supplemental retirement income, as a source of survivorship benefits for his or her family, or both.

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1. The company and the executive agree that personal life insurance protection

and the related cash value accumulations are important components of the

executive’s overall compensation package. Depending on the relationship

existing between the parties, this understanding may be formalized through

an optional supplemental employment agreement.

2. The executive acquires a cash value life insurance policy on his or her life.

3. The company makes the premium payments on this policy, which are taxed

as additional compensation to the executive. Optionally, the company may

provide an additional cash bonus to the executive to cover the tax

associated with the premium payment.

4. The policy cash values are available to supplement retirement income

through withdrawals and loans. Loans and withdrawals may generate an

income tax liability, reduce available cash value and reduce the death benefit

or cause the policy to lapse. The policy death benefit will be distributed

income tax-free to the executive’s beneficiaries.

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Read from slide

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A REBA is essentially an executive bonus plan (or Section 162 bonus plan) with

an added supplemental employment agreement that requires the executive to

remain with the Employer for an agreed upon period of time. The supplemental

agreement is backed-up by a restrictive endorsement filed with the insurance

company.

Thus, a restricted executive bonus plan (“REBA”) is an arrangement where an

employer makes premium payments on a cash value life insurance policy owned

by an executive and the parties also enter into a supplemental employment

agreement spelling out the terms and conditions that motivate the executive to

remain with the employer for an agreed upon period of time. While the

executive must recognize the premium payments as ordinary income, after

expiration of the policy restrictive rights the executive can use the policy as a

source of supplemental retirement income, as a source of survivorship benefits

for his or her family, or both.

***The policy cash values are available to supplement retirement income through

withdrawals and loans. Loans and withdrawals may generate an income tax

liability, reduce available cash value, reduce the death benefit or cause the

policy to lapse.

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1. The company and the executive agree that personal life insurance protection

and the related cash value accumulations are important components of the

executive’s overall compensation package. Depending on the relationship

existing between the parties, this understanding may be formalized through

an optional supplemental employment agreement.

2. The executive acquires a cash value life insurance policy on his or her life.

3. The executive and the company execute a “restrictive endorsement” to the

life insurance policy giving the employer a veto power over most decisions

regarding ownership and administration of the policy cash values.

4. The company makes the premium payments on this policy, which are taxed

as additional compensation to the executive and create a current deduction

for the employer. Optionally, the company may provide an additional cash

bonus to the executive to cover the income tax associated with the premium

payment.

5. The “golden handcuffing” incentives provided by the supplemental

employment agreement encourage the executive to remain with the

employer for the agreed upon period of time. Following expiration of the

agreed upon term, the policy cash values are available to supplement the

executive’s retirement income through withdrawals and loans. Loans and

withdrawals may generate an income tax liability, reduce available cash

value, reduce the death benefit, or cause the policy to lapse. The policy

death benefit will generally be distributed income tax-free to the executive’s

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beneficiaries.

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Your Voya representative has a specialized tool – the Executive Benefits Wizard

– to help you choose a plan design that will best meet the needs of your

business.

The executive benefits wizard applies the twelve factors we have discussed to

the seven alternative plan designs outlined earlier in this presentation

(NQDC/SERP arrangements, split dollar loan arrangements, NQDC/split dollar

combo arrangements, endorsement split dollar arrangements, survivor income

DBO arrangements, executive (section 162) bonus arrangements, and REBAs).

Ask your Voya representative to show you how the Executive Benefits Wizard

can help you!

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I’d like to help you determine how an Executive Benefits Arrangement might be

right for you or your employees. Would you like me to create a customized

proposal to meet your needs?

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