When a business owner dies, key employees may be concerned about the future and think about leaving the business. A stay bonus strategy can help retain key employees by providing a financial incentive to stay.
Preserving business value after an owner’s death
Why choose a stay bonus strategy?
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How it works
1. The business purchases a life insurance policy on the business owner’s life. The purpose of the policy is to provide liquidity to potentially pay bonuses to select key employees after death of the owner.
| Owner | Why? | Considerations | Other objectives |
|---|---|---|---|
| Business owner | Business owner can access the policy | Must be included in the owner’s estate | Supplemental income, income replacement, legacy strategies |
| Business | Business pays policy premiums | Cash value and death benefit is paid to the business and tax issues may arise when taking these funds out of the business | Key person, entity redemption buy-sell |
| Irrevocable life insurance trust | Keeps the policy out of the business owner’s estate and outside the reach of business creditors | Prevents the business owner from accessing the policy |
Estate tax planning, legacy strategies |
2. If the business owner dies, a bonus agreement is executed to retain the key employees by providing a financial incentive to stay with the business.
3. The life insurance policy’s death benefit proceeds provide the funds needed for the stay bonus.
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View the step-by-step processLife insurance products contain fees, such as mortality and expense charges, (which may increase over time) and may contain restrictions, such as surrender periods.
Please keep in mind that the primary reason for purchasing life insurance is the death benefit.
Additional agreements may be available. Agreements may be subject to additional costs and restrictions. Agreements may not be available in all states or may exist under a different name in various states and may not be available in combination with other agreements.
Policy loans and withdrawals may create an adverse tax result in the event of lapse or policy surrender and will reduce both the surrender value and death benefit. Withdrawals may be subject to taxation within the first fifteen years of the contract. Clients should consult their tax advisor when considering taking a policy loan or withdrawal.
The Policy Design chosen may impact the tax status of the policy. If too much premium is paid, the policy could become a modified endowment contract (MEC). Distributions from a MEC may be taxable and if the taxpayer is under the age of 59 ½ may also be subject to an additional 10% penalty tax.
An annuity is intended to be a long-term, tax-deferred retirement vehicle. Earnings are taxable as ordinary income when distributed, and if withdrawn before age 59½, may be subject to a 10% federal tax penalty. If the annuity will fund an IRA or other tax qualified plan, the tax deferral feature offers no additional value. Qualified distributions from a Roth IRA are generally excluded from gross income, but taxes and penalties may apply to non-qualified distributions. Please consult a tax advisor for specific information. There are charges and expenses associated with annuities, such as surrender charges (deferred sales charges) for early withdrawals.
This information may contain a general discussion of the relevant federal tax laws. It is not intended for, nor can it be used by any taxpayer for the purpose of avoiding federal tax penalties. This information is provided to support the promotion or marketing of ideas that may benefit a taxpayer. Taxpayers should seek the advice of their own tax and legal advisors regarding any tax and legal issues applicable to their specific circumstances.
For financial professional use only. Not for use with the public. This material may not be reproduced in any form where it is accessible to the general public.
DOFU 10-2022
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