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When Does A Non-Qualified Benefit Plan Make Sense?

Both business owners and executives can benefit from non-qualified benefit plans. When considering which options make the most sense, the questions revolve around:

  • What the business owner wants to achieve from offering the plan
  • What the non-owner executive finds valuable in an offering
  • What the structure of the business is to assess whether or not there exist tax advantages

The types of non-qualified plans that benefit business owners include:

  • Personal Retirement Plan (Life Insurance in Retirement, Deferred Annuities or Non-Deductible IRAs)
  • Split Dollar Plan (For death benefit protection needs or retirement accumulation)
  • Bonus Plan

The types of non-qualified plans that benefit non-owner executives include:

  • Deferred Compensation or Salary Deferral Plan

From the Business Owner’s Perspective

Personal Retirement Plan

A Personal Retirement Plan can be considered for business owners whose business structure limits its ability to achieve tax leverage through the company. A Personal Retirement Plan is used typically for sole proprietors, personal service corporations, and pass through companies like partnerships, S-Corporations and LLCs.  The key question when designing a personal retirement plan for a business owner is “what is the best after-tax planning vehicle available?”  This may be a LIRP (Life Insurance In Retirement), a deferred annuity or a traditional non-deductible IRA or ROTH IRA.

Split Dollar Plan

When the corporate tax bracket for the business owner is significantly lower than the personal tax bracket, a Split Dollar Plan may make sense.  By paying the life insurance premium at the lower corporate rate, and taxing the business owner on a small portion of the premium that represents the economic benefit of the insurance amount, tax leverage can be gained. The split dollar plan can offer the business owner the opportunity to provide for his or her liquidity needs for estate planning purposes, or to use the policy as a form of tax advantaged supplemental retirement income.

Bonus Plan

A Bonus Plan is beneficial to business owners who want to fund personal life insurance for either death benefit protection or retirement accumulation needs.  A Deferred Annuity may also be used for accumulation needs.  A Bonus Plan is used when a business owner’s personal tax bracket is equal to or lower than the corporate rate.  This typically happens in personal service corporations, high net profit corporations, or where the business owner has a low tax bracket due to large write-offs such as charitable donations. By taking an income tax deduction in the higher corporate tax bracket, and taxing the owner in his or her lower personal bracket, tax leverage can be gained. Taking money out of the company in the form of a bonus also eliminates possible double taxation in the future, which occurs when money is left in the corporation.

From the Non-Owner Executive’s Perspective

A Deferred Compensation Plan can be used for non-owner executives. It can also be used for business owners who happen to have a higher personal tax bracket than the corporate bracket, provided that the business owner is not a majority owner. Deferred Compensation is not recommended for a majority owner whether or not tax leverage can be gained. By leaving money in the lower corporate bracket, higher personal taxes can be delayed until a later date such as retirement.

A Deferred Compensation Plan can be used with an owner of an S-Corporation or Partnership who has a very small ownership percentage. However, given the pass-through nature of S-Corporations and Partnerships, owners pay tax on profits whether they leave them in the company or take them out. Consequently, Deferred Compensation offers no tax leverage.

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Lina Storm, CLU®, ChFC®, MBA

Lina Storm, CLU®, ChFC®, MBA

Vice President, Field Marketing at Highland Capital Brokerage
Lina Storm serves as Vice President, Field Marketing for Highland Capital Brokerage. She has an extensive background in marketing insurance and advanced planning strategies having spent most of her career leading the marketing for John Hancock’s notable Advanced Markets Group. She has been an industry thought leader, industry columnist, advisor’s coach, trainer, speaker, and brand strategist—helping advisors position their expertise, add value, and drive sales. Lina is a CLU®, ChFC® and received her B.A. from Trinity College in CT and an M.B.A. from Rensselaer Polytechnic Institute in New York.
Lina Storm, CLU®, ChFC®, MBA

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