One of the most important challenges business owners face is retaining their key performers, whether those are members of their leadership team, sales staff or operations group.
The traditional tools for rewarding and retaining key performers — equity opportunities, “phantom” equity programs and deferred compensation arrangements — generally involve fairly complex legal, administrative, accounting or tax work. Of course, there are other considerations that make these options the right or wrong choice, but “simplicity” is generally not a word that comes up in connection with any of them.
A relatively easier and more effective way to reward key employees — and keep them a part of the team for years to come — is an option we’ve recommended with increasing frequency to our clients: the “Golden Executive Bonus Arrangement” (GEBA).
Sometimes called a restrictive endorsement bonus arrangement, a GEBA is often adopted by owners of S corporations and limited liability corporations (LLCs) as part of the compensation and benefits package for key employees, for a number of reasons:
— Contributions by the company are tax-deductible bonuses (reported as W2 wages)
— There are no participation or eligibility rules, meaning employers can selectively cover key employees
— The plan design is highly customizable, with no specific restrictions on the amount of annual contributions (other than the usual “reasonable compensation” requirements)
— There are no annual administrative, accounting or reporting requirements, making the cost of plan administration nominal
— Key employees receive what is, from a tax standpoint, a Roth-like benefit (i.e., after-tax contributions, tax-deferred growth and distributions that should not be subject to tax)
— Participants can only access the benefit upon meeting the vesting, performance or service requirements set by the employer
— The employer has flexibility in funding or terminating the arrangement
How Do GEBAs Work?
In a GEBA, the company and key employee enter into an agreement specifying that the employee will be eligible for bonuses and spelling out vesting and other qualification provisions. The company then pays annual tax-deductible bonuses to the employee, which the employee takes into taxable income (many employers “double bonus” to cover the income tax consequences).
The annual bonuses are deposited into a specially designed life insurance policy insuring the key employee. The employee and company are parties to an endorsement on the policy, which restricts the employee’s access to the cash value per the provisions of the plan’s agreement. The policy cash values can be invested in a wide array of “brand name” investment choices, at the discretion of the key employee.
Upon meeting the qualification provisions of the plan agreement, the key employee can access the policy cash values (including any accumulated investment earnings) via tax-free withdrawals of policy basis, or loans against the policy values. As it’s a life insurance policy, the key employee’s named beneficiary receives the death benefit, net of any loan balance, after the employee passes away.
If the key employee fails to meet the vesting or other qualification requirements under the agreement, it recovers non-vested bonus payments from the policy cash value.
Are There Downsides to GEBAs?
A GEBA requires the key employee be healthy enough to acquire the life insurance policy required to finance the plan, so it will not be applicable to every key employee. Another potential drawback is that the cost of life insurance under the specially designed life insurance policy typically creates a drag on investment return of 0.50–1.25%, depending on the health and age of the key employee.
But for key employees who can qualify for life insurance coverage, the life insurance expense drag can be a small price to pay for a very attractive addition to their compensation and benefit package — one that provides considerable incentive to remain a key contributor for years to come.
For business owners looking for a simple, low-cost and tax-deductible means of retaining key people, the GEBA can be a great option.
Interested in learning more? Get in touch with our team today.
