Salary Continuation Plan: An Incentive Compensation Alternative for Key Executives

Every company has key executives who influence decisions that affect its success. These individuals are an asset to the company. Tough to find and even more difficult to replace. Despite the value and success, they are bringing to their company it is not farfetched for a valuable employee to leave their company or position due to retirement plans or being attracted by a competitor offering a higher salary and better benefits. When a company finds itself in this situation, it is now faced with the challenge of having to quickly replace and retrain key employees. To avoid this loss or break in the company’s executive employee infrastructure and the expense of investing all over again in a newly hired executive to build value and loyalty, it only makes sense for a company to provide comprehensive benefits and make significant investments into key executives to attract and retain their skills and expertise.

In today’s competitive employment market, it is essential to give more than standard benefits to retain the most valued employees. Retention of highly valuable employees based on the standard qualified retirement plans under current tax legislation no longer has the competitive edge necessary to commit executives to a company. This means a highly rewarded key employee who is very valuable may not be able to retire satisfactorily with the current traditional benefits permitted by law. This is when a nonqualified Salary Continuation Plan can provide a solution to this situation.

 

What is a Nonqualified Salary Continuation Plan?

A nonqualified salary continuation plan is a plan companies utilize to provide key executives and general employees with additional source of retirement income, or in some cases provide income to beneficiaries of the insured if there is a sudden death or illness. It has a wide degree of flexibility and benefit. One of the most attractive being it allows corporate officers’ discretion regarding who can be promised benefits and how large those benefits can be. A salary continuation plan is set up between the employer and employees and is funded by the employer. The benefits provided under the plan will determine the cost of the plan. Benefits are usually predicated on a certain percentage of the insured’s salary and length of employment. In return, the employee promises to stay with the employer until retirement. The plans are usually fully funded by the business to benefit the valued employee in the future. A salary continuation plan, often financed by permanent cash value life insurance, can be constructed so the company can recoup its costs while also providing an income tax-free deferred benefit to the key employee.           

How does it work?

  • The employer and employee agree in writing that the company will pay a set amount each year upon the employee’s retirement, death, or termination. There are no out-of-pocket expenses for the key employee. 
  • The company puts aside cash to support the plan informally. The employee’s interest might be subject to benefit vesting based on the employer’s discretion. 
  • The employee or specified beneficiary receives the agreed-upon benefit as regular income upon retirement, death, or termination. The company obtains a tax deduction when the benefit is paid. 
  • Benefit funding and subsequent payment are at the discretion of the company. Any informal finance is susceptible to the company’s creditors’ claims.

What are the advantages Of Salary Continuation?

  • In addition to appropriate retirement plans, salary continuation plans provide a supplemental source of retirement income for key executives.
  •          It reflects the employer’s regard for the employee, which encourages employee loyalty.

  •       Attracts and retains key employees 

  •           Save a considerable amount of money by avoiding unnecessary taxation.

  •      The company has the option of selecting plan participants on a case-by-case basis.

  •      Plans are adaptable, and expenditures may be recovered.

Life insurance as part of the plan

Life insurance is an excellent vehicle to fund a salary continuation plan. It is a one-of-a-kind revenue source because it can provide a substantial pre-retirement death benefit and tax-deferred cash value accumulation for retirement income. In a nonqualified salary continuation plan using life insurance purchased on the employee to fund the plan is the typical route for most employers. The accumulated cash value of the life policy can be used to pay the benefit when it comes due. And if the company must pay the benefit out of available cash the company is reimbursed upon the insured’s death because the company is the beneficiary of the employee or key executive’s life insurance policy. The company does not receive a tax deduction on the premiums paid since it is the owner and beneficiary of the life insurance policy of the employee. 

Tax Consideration in Salary Continuation Plan

When using life insurance as the financing mechanism for a Salary Continuation Plan, there are various tax considerations to note:

1. The company’s life insurance premium payments are not immediately tax deductible.

2. The company might deduct the number of delayed benefits provided to the key executive or his beneficiaries.

3. The employee or their beneficiaries must pay ordinary income taxes on all salary continuation plan benefits received.

How Can We Help?

HWA Alliance of CPA Firms, Inc. can help you determine if a salary continuation plan is a smart solution for your company. Our well-trained financial and advisory experts can help guide and direct you towards reliable resources to selectively reward your highly valued employees with an appealing benefits plan at a low cost. As well as attract and retain employees by providing the right employee benefits plan for your business needs. Allow us to accompany you in choosing the best option for your company’s future.


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