More often than not, keeping a family-owned business in the family is a top priority. However, to keep the business successful, the family may have to attract outside talent. This was a situation of a manufacturer we worked with. The company had experienced some difficult times, and recruited a turnaround specialist who was able to substantially improve the company’s long-term outlook.
This particular executive was so coveted, that the business wanted to find a way to keep him loyal for the next 10 or 15 years; however, providing him equity ownership in the company was not something they were willing to do. Furthermore, since the company was privately owned, determining the equity price was much more difficult than it would have been for a publically traded company.
We took a page out of the playbooks for Fortune 500 companies and helped the manufacturer establish a nonqualified benefit supplemental executive retirement plan (SERP). Many large companies use SERPs to provide benefits over and above the executive’s compensation package to ensure an executive team stays together and will remain with the company long term.
The formal agreement we developed between the family-owned manufacturer and the turnaround specialist spelled out that the specialist would stay at the company for a minimum of 10 years, and in turn, the company would generate a $200,000 payment for his retirement yearly for the 10 years following his tenure. This agreement aligns the company’s desire to have this executive on board to carry the company into the future. In turn, the executive is incentivized to ensure the company is successful because the risk of forfeiture is very real. If the company were to fail, his retirement arrangement would disappear. He not only has to ensure the company is successful during his tenure, but he also needs to set up successive management to be prosperous for many years to come to ensure his payments in retirement.
For the company, the promise to the executive is a liability on their books for the life of the contract—in this case, 20 years: the 10 years the executive would stay with the company and the following 10 years when the benefit would be paid out. We found the best avenue for funding this liability was through company-owned life insurance on the life of the executive. The company would be both the policy owner and the beneficiary and would retain the rights to the cash value and the death benefit. The corporation would eventually draw against the accumulated cash value to pay the distributions promised under the nonqualified benefit SERP.
The benefit to using life insurance is that if structured properly, the cash value that accumulates is not subject to tax. The IRS treats the withdrawals of the accumulated cash value as a nontaxable recovery of investment in the contract. Furthermore, the company can deduct the amounts paid to the executive under the nonqualified plan that is funded by the company-owned life insurance policy in the year the payments are made. The tax-favored treatment of the life insurance policy made it economical for the company to have this liability on their books. When used in this manner, the life insurance policy is very specific designed for these programs and must be structured properly for all parties to benefit.
In the end, the manufacturer was able to retain top talent in this executive and keep the ownership of the company in the family. If you have questions how a supplemental executive retirement plan may benefit your company, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.