A Small Business’ Solution to Long-Term Success

Smaller corporations often face two problems:  the hiring and retention of key employees, and an inadequate retirement benefits payable to owners and key employees.  The solution to this problem can be a selective executive retirement plan.

Most prosperous businesses have one or more crucial employees who are largely responsible for the success of the corporation.  When one of these key individuals ends employment, the business can encounter one or more of these problems:

  • Reduction in Earnings
  • Disruption of Management
  • Replacement Costs
  • Credit Problems
  • Confidence Problems
  • Competition

Some questions to examine when determining if a selective executive retirement plan is required:

  • Are there any key employees at the company?
  • Are major portions of sales or profits attributable to a few key employees?
  • Is business management determined by a few key executives?
  • How much of an expense would the company incur to recruit, hire, and train a substitute for a key employee?
  • How will creditors respond to the passing of a key employee?
  • How will customers, merchants, and other employees act in response to the loss of a key employee?
  • Will the previous employee create a competing business?
  • Since salary by itself is often not enough, what can a business do to keep its key employees?

Benefits of a Selective Executive Retirement Plan

A Selective Executive Retirement Plan can offer tailor-made benefits to certain key executives in the company.  With complete flexibility in who is chosen to participate in the plan, salary continuation amounts, and the length that benefits will continue, a company can offer different benefits to different key employees.  This makes a Selective Executive Retirement Plan the perfect vehicle for attracting and keeping key employees.

Funding of a Selective Executive Retirement Plan

Unfunded and unsecured are two key words to remember when avoiding taxation until the benefits are received by selected key employees.  To implement a successful Selective Executive Retirement Plan, a company must create a future liability for any promised benefits. A perfect way to do this is to purchase life insurance on each key employee.  An added bonus to using life insurance owned by the corporation is that the company may be able to fully recover any costs, including the cost of the life insurance premium.

The process of a Selective Executive Retirement Plan

An effective way to attract and retain important key employees is to provide them with benefits that are over and above those that are offered to all employees.  The process involves the corporation, key employees, and the insurance company, with the company acting as the middleman between the key employee and the insurance company.

The benefits to a company that uses a selective executive retirement plan include:

  • First, the company makes a salary continuation agreement with the key employee.  In this agreement, benefits to be provided are spelled out along with the terms to receive these benefits.
  • Next, the company purchases enough life insurance on the key employee to fund the after-tax cost of any agreed-upon benefits.  The company can also purchase additional insurance to recover the nondeductible premium costs.
  • Finally, the purchased life insurance policy, owned by the company, pays the premiums on the life insurance and is named the beneficiary of the policy.

One way a Selective Executive Retirement Plan that is informally funded with life insurance could be paid from:

  • If a key employee stays actively employed until retirement, the business pays the guaranteed tax-deductible retirement benefit from up-to-date cash flow, loans or withdrawals from the policy’s cash value, or a combination of the two.
  • If the key employee dies before retiring, the death benefit is then received income tax-free to the owner of the policy, which is the company.  Then, the company uses this income tax-free death benefit to pay survivor benefits to the family of the key employee.
  • If the company maintains the life insurance policy after the key employee retires, at the key employee’s death, the corporation receives the death benefit income tax-free and recovers any costs it procured in paying the premiums on the policy.

Plan Features of a Selective Executive Retirement Plan

There are several plan features to the company that utilizes a Selective Executive Retirement Plan:

  • The corporation can hand-pick those employees who will be integrated in the plan and can adjust the benefits offered to each selected key employee.
  • The plan affords a robust incentive for the selected key employees to stay with the company until retirement.
  • A Selective Executive Retirement Plan may be utilized to entice new executive talent.
  • Salary extension retirement benefits can be stipulated as a supplement or substitute for qualified retirement plan benefits.
  • Salary continuation benefits are tax deductible as disbursed to the employee or the employee’s family.
  • Life insurance can be utilized to recoup the cost of delivering promised benefits.
  • Although life insurance premiums are not tax deductible, the death proceeds normally are received income tax-free, presuming employer-owned life insurance requirements have been met.
  • Life insurance policies are assets of the company, which may increase the company’s creditworthiness.
  • No approval of the plan is needed from the IRS.

In addition. there are several plan features to the key employee that receives a Selective Executive Retirement Plan:

  • Participating key employees sustain no current income tax liability.
  • Additional spendable income may become accessible as expenses for individually-purchased protection are reduced.
  • Retirement benefits may be used to “sweeten the pot” of qualified retirement plan benefits.
  • Participating key employees remain eligible for all other company-provided fringe benefits.
  • A Selective Executive Retirement Plan delivers solid acknowledgment of an executive’s contribution to the success of the business.

By using life insurance as a tool to attract, keep, and satisfy key employees, a small corporation is able to remain competitive with larger companies and ensure the future of the company.  

As with any complex financial endeavor, a qualified financial advisor who is knowledgeable in all aspects of life insurance, including Selective Executive Retirement Plans, should be utilized.  Not doing so could mean the difference between a small corporation’s success or failure. It is never too late to rethink retirement benefits offered to all employees.

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