Key Man Insurance Buy Sell Agreement

Sometimes companies go through transitions, are acquired or have a change of head management. Sometimes key employees are not happy with the successors or dislike the new manager’s direction for the business. Losing a key person’s skills, experience, relationships, loyalty and talent can be troublesome at any time, but it is especially harmful during a time of transition, therefore it is in the firm’s and management’s best interest to incentives these key men. Life insurance can provide a financial incentive for key employees to remain with the company during transition with an executive bonus arrangement or a non-qualified deferred compensation agreement.

These are both simple, flexible, and cost-effective ways to reward and retain key employees. Let’s take a closer look at these two arrangements in detail.

So, What Is an Executive Bonus Arrangement?
An executive bonus arrangement (sometimes known as “golden handcuffs”) is designed to reward key employees as an incentive to keep them with the company. It does so by providing personal life insurance along with other enticing financial incentives, such as:

  • portable policy benefits (policies can be taken with the key employees when they leave)
  • tax-deferred cash accumulation (permanent insurance only)
  • full (or delayed) borrowing and withdrawal privileges (full or restricted access to cash accumulated)
  • Tax-free death benefits to the employee’s family (the best thing about life insurance is the tax-free benefit to the key employee’s family)
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How an Executive Bonus Arrangement Works
  • The employee applies for and owns a permanent life insurance policy and selects the beneficiary.
  • A separate written agreement provides that the business will pay the premiums on the policy by way of a bonus if the employee remains with the company. The bonus is treated like any other compensation by the company and the employee.
  • A business owner may choose a restricted executive bonus arrangement, using a policy endorsement to place restrictions on the employee’s rights under the policy. Some of these restrictions may be access to the cash values, loans using the policy as collateral, or the ability to surrender the policy and take the net cash value.
  • All restrictions end at a specified time—upon retirement, on a certain date, or with the employer’s permission.
  • Some employers enter into a corresponding employment agreement stating that if the employee leaves the company prior to the specified time, the employee must pay back all bonus payments.

I have known the proprietor of East Coast Financial for over 20 years and from the day I met him, to shortly after when he managed my money, I knew he and his organization is one I could trust.

– Robert Leaman | Retired | Former Owner Compressed Gas Solutions

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What Is Nonqualified Deferred Compensation?

Another way to reward key employees is with a non-qualified deferred compensation arrangement. This is a contractual arrangement between the employer and employee, that specifies when and how future compensation will be paid. When properly arranged, employees can defer taxation until benefits are paid at a future date.
This arrangement provides key employees with an opportunity to accumulate substantial and meaningful retirement benefits beyond more restrictive amounts that qualified plans offer.

Here’s how nonqualified deferred compensation works:

  • The business agrees to pay key employees a specified amount of future compensation.
  • Payments may be for a fixed period or for the employee’s lifetime.
  • Deferred compensation is typically not a true salary deferral, but rather a commitment to pay an amount in addition to current compensation at a designated time in the future.
  • The plan is unfunded, so key employees pay no income tax on the promised benefit until funds are received.
  • The business unofficially “funds” the plan by buying life insurance on key executives.

Why Life Insurance?

Since avoiding current income taxation is a primary objective in these arrangements, key employees who will receive promised benefits must not enjoy a current economic benefit. Life insurance is ideally suited to meet these unfunded arrangement requirements because the policy is owned by the business. As a corporate asset, the policy is available to creditors, and the employee has no beneficial ownership rights in the policy.

Life insurance also ensures that funds are available to pay promised benefits with no drain on future earnings. The graphic below summarizes how deferred compensation works.

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Key Man Insurance Buy Sell Agreement
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