Executive Bonus Arrangements
The Scenario
Mark Lacey dropped out of college to start Zehta
Graphics, Inc., a computer software company
specializing in 3D animation. Mark poured all his time and money into the business, but growth was slow. There were even times Mark thought the company might go under. Then he hired Steve Hobbs.
Steve’s innovative design style allowed them to acquire their first high-profile assignment for an independent movie studio. Their work on the project was highly regarded, and numerous similar projects followed. Mark has given Steve raises and bonuses. He hired more people and put a retirement plan in place. The company
has grown, and their services are now in such high
demand that they have their pick of projects.
Mark feels that he owes the success of his company to Steve’s creativity and technical genius. He’s also fearful that another company might try to lure him away. He wants to reward Steve in a way that encourages him to stay with the company. He already pays Steve a competitive salary and annual bonuses, and Steve participates fully in the retirement plan. Mark turns to his advisor, Mary Castellani, to talk about his options.
CHARACTERS AND CONCERNS
Mark Lacey – At age 40, he is the
founder of Zehta Graphics, which
has become one of Hollywood’s
go-to animation companies.
Steve Hobbs – A successful
animator and key employee at
Zehta Graphics, responsible
for their first big break and
the quality and innovation that
ensured their continued success.
His name is well known in the
industry and other companies
would love to have his talent. He
is 30 years old, married, with his
first child on the way.
A Planning Strategy
Mary suggests that Mark use an executive bonus
arrangement. Mark could use tax-deductible funds to provide valuable benefits to Steve without having to include any other employees. In this case, the benefit would be a cash value life insurance policy that would provide Steve’s young family with extra protection. The policy is portable if Steve leaves the company at some time in the future. In addition, Steve can access the cash value to supplement qualified plan funds during retirement.
Mark is on board with the idea, and instructs his attorney to create a written agreement. Steve applies for a life insurance policy on his own life and names his wife as the beneficiary. Mark pays Steve an additional annual bonus in an amount designed to cover the life insurance premium and the tax Steve will pay on the bonus. (Mark
is able to deduct the cost of this bonus, but of course, it is taxable to Steve as compensation.) And if Mark should ever want to end the agreement, he could simply stop paying the bonus.
The agreement grants Steve delayed access to the
policy’s cash value starting at age 50, using tax-free
loans or withdrawals. This can provide an important
supplement to his retirement income.
Because Mark is concerned with keeping Steve with the company, he also enters into a second agreement with Steve. If Steve leaves the company before age 40 (10 years from now), he is required to pay back all bonuses received under the executive bonus arrangement.
MORAL OF THE STORY
An executive bonus arrangement
is extraordinarily flexible. It
helps an employer accomplish
the dual goals of rewarding one
or more key employees and
keeping them with the company.
It also provides the selected
employees with an important
benefit—added protection and
full or limited access to the
cash value. The arrangement is
simple to implement and easy
to administer, and is not subject
to the rules and regulations that
apply to qualified plans.
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