While retirement may still seem eons away, it's never too early to start planning for your financial future. Employers sometimes use life insurance policies to fund non-qualified employee retirement plans. This type of contract does double duty. It insures your life and gives you access to the policy's accrued cash value when you retire. Because the government doesn't regulate non-qualified pension plans as closely as qualified plans, a deferred compensation plan or one funded with life insurance costs your employer less to administer and allows for flexibility and customization; these plans are most often offered to highly paid executives.
Deferred Compensation Plans
Non-qualified pension plans, such as deferred compensation plans, are not subject to the limitations on contribution amounts set by federal law. This makes them an attractive benefit to high-earning employees. Since earnings are paid out at a future date, you can defer paying taxes on the income until you retire. Deferred compensation plans include deferred savings plans and supplemental executive retirement plans. The difference between the two plans is that you contribute to a traditional deferred savings plan, whereas a supplemental executive plan is funded entirely by your employer. A deferred savings plan is similar to a 401(k) plan in which you contribute a certain percentage of your earnings and your company matches a portion of that amount.
Executive Bonus Plans
Rather than paying an employee a cash bonus, some companies provide additional benefits in the form of life insurance or annuities. With an executive bonus plan, your employer pays the premiums on a cash value life insurance policy. Many employees elect to use the cash value in the policy as a source of retirement income, which, depending on how the plan is set up, can be a substantial asset. The premiums your employer pays are considered part of your compensation, so that amount is included in your taxable income. Your employer can deduct the cost of an executive bonus plan as a business expense.
Split-Dollar Life Insurance
With a split-dollar life insurance plan, both you and your employer share ownership of the policy. Employers sometimes use this type of insurance plan to provide employees with a supplemental retirement plan. The catch is your employer is entitled to a percentage of the policy’s cash value or death benefit. A split-dollar plan works in one of two ways. Either your employer owns the policy and signs over a portion of the cash value or death benefit to you, or you own the policy and assign a portion of the policy’s cash value and death benefit to your employer. Since the employer holds an interest in a split-dollar plan, the premiums the company pays are not deductible on taxes as a business expense. Your employer’s portion is collateral for paying your insurance premiums.
Sometimes a company selects certain employees to receive a cash value insurance policy instead of group term coverage. An employee can use the cash value the policy accumulates as retirement income. In fact, carve-out plans are becoming more popular as a source of retirement income, especially for highly compensated employees. A carve-out plan often is cost-effective for the employer because it reduces the cost of term life insurance coverage for other employees. The premium your employer pays is considered compensation. Although you must pay taxes on the additional income, your employer can deduct from taxes the premiums it pays.
Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering business and finance, health, fitness, parenting and senior living issues for both print and online publications. Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.