Executive Bonus Plans: 12 Smarter Ways to Fund Your Retirement and Lower Your Tax Liability at the Same Time
Are you a business owner?
Want a new method on how-to invest business profits to reduce taxes?
And do you want to reduce your tax liability, fund your retirement, and secure life insurance at the same time?
If so, then you should consider putting Executive Double Bonus Plans in place.
Executive Bonus Plans (EBP's) or Executive Double Bonus Plans (EDBP's) are fast replacing deferred compensation plans as the "standard" death and retirement plan and tax reduction strategy for both S and C corporations.
Here are 12 advantages of EBP's for your business, your employees, and yourself.
#1: No Ongoing Liability.
One of the biggest grips business owners have with deferred compensation plans is the ongoing liability. Deferred compensation will always be a big and ugly mark on the balance sheet.
With Executive Bonus Plans, there's no ongoing liability. You'll only need to pay out individual premiums as "wages."
And speaking of said wages...
#2: Immediately Tax-Deductible.
With deferred compensation, the wages are "tax-deferred" – that is, the taxes are due upon withdrawal. To an S corporation owner, that setup makes no sense – they'd be paying income taxes and deferred taxes on the same dollars.
With Executive Bonus Plans, you'll only need to pay taxes on the premiums once. Because the premiums can be paid out as bonuses, which is considered "reasonable compensation."
[QUICK NOTE: EDBP's are sometimes referred to as "Section 162 Bonus Plans," because they relate to the Internal Revenue Code (IRC) Section 162(a)(1), which details how employers can deduct the bonus paid to cover the premium as "reasonable compensation."]
Now, why is it called a "Double Bonus" plan? It's all to distinguish it from the "Single Bonus" type of plan, where the owner pays the premium, but the employee pays the tax on the premium.
In Double Bonus plans, the owner pays the premium, then provides the cash to the employee (as a "bonus") to cover the tax on the premium. Applied to yourself, this essentially makes it a tax-free way to extract income from your business.
#3: Death and Retirement Benefits
The best EBPs use permanent life insurance policies as their vehicle. These policies allow you to provide life and disability insurance to yourself and your key employees – all using tax-deductible dollars.
This is probably the main reason why Executive Bonus Plans are among the top tax reduction strategies in the small business world.
#4: Same Cost as Deferred Compensation Plans (Or Even Less)
Deferred compensation plans force you to set aside money that your business could otherwise use to generate cash flow (valuing at least your tax bracket's worth). What's worse, you'll also need to cover administrative fees and other costs.
With EDBP's, you put the amount in individually-owned policies or contracts. You'll then gross-up the policyholders' income to cover the tax they would have to pay. With that setup, the policyholders will incur zero net cost.
Executive Double Bonus Plans have no administrative fees to cover, making them the new ideal executive bonus structure.
#5: Win-Win With Your Key Employees
You may also consider using insurance and or retirement plans to attract, retain, and motivate your key employees. Executives tend to be suspicious about deferred compensation plans, as the company might default in the future and be unable to payout.
Defaulting is a non-issue with EDBP's. The employees themselves own the policies or contracts, so even if the company defaults, they'll still get their benefits. What's more, they get to choose their death benefit beneficiaries.
As the business owner, you also can structure the plan as a restricted executive bonus agreement (REBA). This agreement lets you put conditions for the employee, such as working for the company for a minimum number of years.
(QUICK NOTE: This article is primarily for informational purposes only. Consult your tax and legal advisers before creating a REBA.)
#6: Tax-Free Death Benefits
With Executive Bonus Plans, death benefits are paid out tax-free. Tax-free death benefits are usually uncommon with deferred compensation plans, where unpaid business taxes need to get covered.
#7: Tax-Free Withdrawals on Retirement
When a policyholder retires, the policy's cash values become available for retirement income, and withdrawals will be tax-free.
Some savvy business owners use their retirement income to secure loans against their policies' cash value – something to consider.
#8: Lower Taxes Over Long Term
With qualified retirement plans like the 401(k), contributions are tax-deferred and will be due upon withdrawal. Meanwhile, with EBP's, only the premium is taxed. If the policy's cash value grows, it avoids any corresponding tax.
Financial experts call Executive Double Bonus Plans "paying tax on the seeds and avoiding tax on the harvest." It's true.
#9: Frees Up Personal Funds
Typically, you'd have to spend your "personal" funds to get the life insurance you need. With Executive Double Bonus Plans, you will free those funds for use elsewhere.
Now, do you see why EBP's are ideal tax avoidance strategies for small businesses?
#10: Individually Owned
Qualified retirement plans also have the disadvantage of relying on the business's profitability. With EDBP's, each policy is individually-owned and unencumbered by the company.
When life insurance is the funding vehicle, then the EBP's will be self-completing. In the event of permanent disability, the premium can be waived.
#12: Easier to put in place
Qualified retirement plans have limitations on who can be covered and for how much. EBP's require no IRS approval and are easier to put in place.
(To clarify: An EBP is a non-qualified bonus plan by definition.)
How To Get Started With Your Executive Double Bonus Plans
Want to learn more about your options? Let us help you. Click here to fill out a free online application, and we'll get in touch to see how we can help your business.
Our goal is to help you design a plan that works best for you, your company, and your key employees. We'll also help you find the perfect insurance provider and assist you in rolling out your plan. Contact us now for a free consultation.
If you want to reduce your business's tax liability, secure a new retirement fund, and get life insurance at the same time, consider Executive Bonus Plans.