162 bonus w/ restrictive endorsement REBA

[CaliBen]

Someone is pitching to our CEO a 162 bonus with restrictive endorsement. CEO is all excited about this. But details presented by broker are somewhat lacking so I have some concerns.

I understand the endorsement limits access to policy values etc. But:

1. Broker indicated that we can include a vesting schedule, and made it sound like we can still take a current tax deduction. Is that correct? With a vesting schedule, does the employee have current taxable income, or only when vested? What about payroll tax?

2. It seems clean enough if the employee stays until restrictive endorsement is lifted, but what if they don't and have to repay the company? Do we (the company) have taxable income for amount of repayment? If the employee paid tax all along, are they just SOL or can they deduct the amount repaid? If so, I assume the are out the payroll taxes, if those were paid all along? What about company - are we also out the payroll taxes?

3. This seems to be moving pretty fast in our C-Suite and I also have concerns about administration. Broker is a small 3 or 4 employee company. Our CEO is considering this plan for 100-150 employees. What kind of administrative support will we need from the broker? This seems like a long term plan and putting it in the hands of a small mom/pop company concerns me.

Thank you

[david rigby]

Get thee to an ERISA attorney. Pronto.

[EBECatty]

I've set up a few of these for clients who have already been persuaded by their brokers, but only for 1-3 employees at a time. I would avoid setting them up for anywhere close to 150 employees.

There are some open issues, but to my knowledge they have never been a high priority for enforcement. The biggest open issue in my view is whether these plans are:

(1) annual bonus plans not subject to ERISA at all

(2) ERISA welfare benefit plans in which the company is helping the employee buy life insurance

(3) ERISA pension plans

If you don't have any restrictions, i.e., company pays premiums each year and employee can do whatever he/she wants with the policy, I think you fall closer to (1) or possibly (2). The more "retirement-like" restrictions you add, e.g., restrictions lapse only upon termination of employment following age 65 or 10 years of service, the more likely you are to fall under category (3). Retirement-based restrictions on 150 employees starts to look an awful lot like category (3).

If they are pension plans, and paying into the policy makes them "funded," they violate a number of ERISA requirements. I've never seen an official pronouncement on their status, but the insurance marketing materials always include a disclaimer saying "talk to your tax and legal advisers to ensure you are not creating an ERISA pension plan, etc." That risk will always be inherent in the REBA plan design, but they are sold nonetheless.

With regard to vesting, the materials I've seen label the process as "vesting" but are really gradually reduced repayment obligations if you leave prematurely. The company also won't be able to deduct any premiums if the company's repayment right can be enforced against the policy (and arguably if the repayment obligation is based on the cash value of the policy).

If you can stomach the risk, they are useful plan designs.

[XTitan]

409A can also rear it's ugly little head depending on the nature of the promise. If the promise is the death benefit, then generally this would fall under the death benefit exemption. If, on the other hand, the commitment is to pay premiums of a specified amount/duration, the legally binding right to future compensation may bring 409A into the picture.

Company deductions for compensation should generally follow vesting. For example, if the company pays 20k per year for 5 years and the program has a 5 year cliff vest, then the employee would have income in the amount of $100,000 at the time of vesting, while the company takes the deduction at that time (subject to reasonable compensation under section 162).

[EBECatty]

As a matter of practice, I've written into the plan document that the company will only pay the premium (and any gross-up bonus) if the employee is actively employed on the premium due date. That way each premium payment is subject to a SROF until made. It doesn't guarantee the employee all premiums will be paid, but is a fair balance in my opinion.

[Mark Whitelaw]

As a recordkeeper / administrator of these types of plans, a few comments / views of plans I've seen.

Remember contributions for any plan can comprise (1) employee, (2) employer subject to vesting schedule and (3) employer not subject to the vesting schedule. Employer can be making contributions from an incentive program subject to vesting and regular bonus contributions to provide all class members $X amount of death benefits. Recordkeeper needs to have capacity to track all three as employee has a right to their money / vested amounts at all times.

Check with the insurance company of how they handle employer repayment security. Most suggest the employer has a collateral assignment that can be exercised if the employee does not repay employer within X-days of termination. A few will honor a springing assignment provision in the REBA providing the employer this one-time loan provision. Remember, insurance company will need / want to review the Agreement in advance.

Many employers take the deduction / add bonus comp to the employee when they make contributions. If the employee does not satisfy the vesting schedule, un-vested repayments are taxable income back to the employer. Employee gets no deduction for their repayment - is SOL. Employer is communicating this tax effect as an added handcuff to promote key employee retention.