By Norman A. Pappas
March 1, 2008
Every business owner depends on key employees who excel at their jobs, keep things running smoothly and make significant contributions to the success of the company. But business owners also know such employees are hard to come by. A top priority, therefore, should be attracting and retaining the best people.
The best incentive is a compensation package that is competitive with other businesses in your industry. Two options are increased salaries and/or additional group benefits. However, salary increases (with their respective taxes) or enhanced group benefits (which must be offered to all employees) may be cost-prohibitive. The best incentives are those that provide employees with a future benefit, encouraging them to stay with the company to realize a later reward.
Non-qualified plans allow employers to provide benefits for selected key employees on a discriminatory basis. Some benefits can be limited to employees of a given class; others can be limited to specific individuals. A secure financial foundation for executives includes disability insurance, life insurance and retirement plans, often provided through group benefits. These types of standard group benefits actually provide less for top managers than they do for other employees.
Most group benefits have limitations which result in reverse discrimination against the highly compensated, in that the coverage provided is lower percentage wise. As a result, these benefits are often insufficient to meet executives’ needs. For example:
-¢ Disability insurance: Group disability plans have a benefit cap. A plan may replace 60 percent of monthly salary, up to a maximum of $3,000, for example. That means employees earning up to $60,000 per year ($5,000 per month) will have the full 60 percent of their salary covered, while employees earning more than $60,000 will receive a smaller percentage. For example, an executive earning $100,000 will only have 36 percent of salary replaced.
-¢ Life insurance: Technically, there is no limit on the amount of group life insurance that can be offered. However, employees must pay income tax on the “imputed economic benefit” of life insurance in excess of $50,000. This is calculated using the IRS Table I rates, which are quite high, thus defeating the “benefit” of additional group life insurance.
-¢ Retirement plans: Corporate retirement plans (such as pension, profit sharing and 401(k) plans) as well as individual retirement plans (IRAs, Simplified Employee Pension and Keogh plans) have contribution limits which discriminate against highly compensated individuals. For example, in 2008 the maximum allowable contribution to a 401(k) plan is $15,500 (catch-up provisions allow higher limits for employees age 50 and older). This allows an employee earning $60,000 a year to contribute 25 percent of salary, whereas an executive earning $200,000 can contribute only 7.75 percent. There are similar limitations on all qualified retirement plans, though there are qualified plans that permit larger deductions for owners and key executives.
Many of these shortcomings can be addressed with creative plans, including:
-¢ Supplemental disability programs
-¢ Supplemental life insurance
-¢ Long term care programs
-¢ Split-dollar life insurance
-¢ 401(k) “top hat” plans
-¢ Supplemental retirement plans
-¢ Phantom stock option plans
You should have a comprehensive benefits program that’s custom-designed to generate the highest degree of dedication and productivity from all of your employees. And, you’ll want to have it re-evaluated regularly to make sure it remains competitive and cost-effective.
Norman Pappas is president and founder of Pappas Financial and the author of several articles on business and estate planning topics. His book, Passing the Bucks, is a guide to business succession and wealth transfer planning. He can be reached at [email protected].