Business Continuity and Succession Plans
Key person insurance and buy-sell agreements allow businesses to continue operations with minimal disruption from death or incapacitation of critical personnel such as an owner, founder, or partner. Given the profound impact of such an event, we recommend our clients consider both policies as part of their business continuity and succession plan.
If your business has highly compensated executives, you may consider offering non-qualified deferred compensation plans and Section 162 executive bonus plans that provide tax-deferral and long-term saving opportunities without the IRS contribution limits.
At Diversified Brokerage, we will help you develop your business continuity and succession planning strategies to meet the needs of your business and your employees.
Section 162 Executive Bonus Plans
An executive bonus plan (Section 162) using life insurance or an annuity is an ideal employee retention program for both employers and top-performing executives because of its tax benefits and group benefit pricing. Like non-qualified deferred compensation (NQDC) plans, this plan allows employers to use tax-deductible dollars and provide a bonus to select employees without violating ERISA’s anti-discrimination rules.
Unlike NQDC plans, employers provide permanent life or disability income insurance, or an annuity to their employees, giving them the policy's ownership rights, including the right to name their own beneficiary(ies) and access the policy cash values. Employers may choose to incorporate an agreement that prevents their employees from accessing the policy cash values without their consent. For example, a vesting schedule may set the number of years employees have to work to receive the full benefit. Death benefits received by the executive's beneficiary (ies) are generally income tax-free, and the plan can be portable.
Non-Qualified Deferred Compensation Plans
A non-qualified, deferred compensation plan (NQDC) enables top employees to defer their compensation until retirement without using a qualified plan. It has many benefits for the employer and employee participants.
Employers can use tax-deductible dollars to contribute to a defined benefit plan such as Supplemental Executive Retirement Plans (SERPs), voluntary deferral plans, wraparound 401(k) plans, excess benefit plans, equity arrangements, bonus plans, or severance pay plans. They can also limit plan participants to valued executives since the plan does not have to comply with ERISA’s nondiscrimination rules.
Employers may use the plan to promote the loyalty of quality employees because deferrals or company contributions are not taxed to them until distribution. Typically there is a vesting schedule, so the employee will have to work a set number of years to receive the full benefit.
The plan can be an attractive alternative to accumulating supplemental retirement income for high-performing executives who have already reached contributions to their qualified plan.
A buy-sell agreement is designed to protect shareholders or partnership interests. Typically used by sole proprietorships, partnerships, and closed corporations, it enables the surviving shareholders or partners to purchase another partner's or shareholder's financial interests upon his or her death, disability, or departure.
Buy-sell agreements can help partners and shareholders manage potentially difficult situations and conflicts of interest in protecting the business and their own personal and family interests. For example, an agreement may prevent the estate from selling the deceased partner's interest to an outsider by stipulating it to be sold back to the remaining owners or the business. It may also restrict owners from selling their interests to outside investors without approval from the remaining owners.
Key Person Insurance
Key person insurance provides financial protection when there is a sudden loss or permanent disability of an owner, founder, or top executives whose overall contribution to the business is vital. This coverage should be an important part of your business continuity and succession plan.
Because your company purchases a life insurance policy on the critical individual's life or potential disability, it pays the premiums and becomes the policy beneficiary. Key person insurance is also called "key man" insurance," "key woman insurance," and "business life insurance."
Key person insurance protects companies in several ways. For example, it can cover profit losses, ongoing loan payments, recruitment fees, lost sales, loss of business contracts, or losses from delay or cancellation of outstanding business projects.