Looking for ways to retain key employees? A restricted executive-bonus arrangement (REBA) is a relatively new and little-known type of bonus plan that can come to the rescue of employers in an increasingly competitive marketplace.
As these arrangements thread their way through the maze of rules and regulations governing qualified retirement plans (those that meet Internal Revenue Service requirements and provide tax advantages) and nonqualified retirement plans (which are employer funded and flexible, but don’t offer tax benefits), small-business owners in particular stand to gain from the tax advantages that REBAs allow.
REBAs can add a layer of benefits to the traditional array of qualified, tax-advantaged plans, such as 401(k)s and simplified employee pension (SEP) plans. (A SEP allows a small employer to contribute directly to an individual retirement account without the complex paperwork and costs typically associated with qualified plans.) Qualified plans like these are usually subject to restrictions, such as antidiscrimination rules that require employers to open the plans to all employees. An employer could be subject to harsh penalties if what the Internal Revenue Service terms “highly compensated employees” receive better benefits than the rank and file.
Because of such limitations, “a lot of executives look to bonus plans when they have maxed out their defined-contribution plans,” says Mark Zingle of Zingle and Associates, a benefits consulting firm in Mendota Heights. Zingle notes that the most an employer can contribute this year to a defined-contribution plan, such as a 401(k), is $45,000 per individual. A catch-up provision allows employers to contribute about $50,000 per year for employees over the age of 50.
This is where REBAs come in handy. A REBA is a nonqualified plan in which the employer selects the employees who will participate in the program, then buys them a life insurance policy or an annuity. The most popular product used to fund REBAs is a variable universal life policy. The employer pays the premium, but the employee owns the policy and gets to choose the investment options that the premium dollars go into.
For instance, an employer purchases a policy and pays $10,000 in premiums. The employee could choose to allocate that money to various investment options within the policy, such as a 401(k). The employer then receives a tax deduction on the value of the vested portion of the payment. The company can also give the employee an additional cash bonus, sometimes called a “gross-up payment,” to cover the taxes the employee must pay on the premium.
This arrangement acts as a retention mechanism because employees lose any unvested portion of the plan if they leave the company. Employers can give different executives bigger or smaller policies depending on their role and position in the company.
“REBAs are catching on within the financial services industry because—if used correctly—they can provide an immediate tax deduction to the employer and an additional benefit for valuable employees,” Zingle says. But he cautions that employer tax leverage shouldn’t necessarily be the main driver of an executive bonus plan.
For employees, “depending on the [plan’s] design, it can take a while before the cash value of the REBA exceeds [that of] an alternative, taxable investment,” Zingle says. For a 50-year-old with a 40 percent marginal tax bracket and a return of 4 percent, it can take three years to reach the crossover point, he says. With returns of 5 percent or more, the crossover period typically shrinks to two years.
With REBAs, as with everything else, the advantages are in the details—and in the performance.
