Employers know that to attract and retain the best talent, they need to offer competitive wages and employee benefits. But providing benefits to highly compensated employees can be tricky. How can employers make sure they are offering the best benefits to attract and retain their top executive talent?
Executive benefits typically fall into two buckets: those that cause equity issues and retention benefits. Equity issues arise when companies try to get benefits for highly compensated employees up to the same level as those provided to rank and file employees, typically the result of either how the group program is designed or qualified retirement plan discrimination testing. Retention benefits can be provided as a tax deductible expense to the employer, and are not treated as income to the executive. In the current competitive employment environment, both of these are important considerations for attracting and retaining key employees.
There is a form of reverse discrimination that occurs in employee benefits that impacts most highly compensated employees. These occur in health and welfare benefit plans as well as retirement savings programs. Some are based on carrier participation limits or practical plan design limitations. Others are built into the Internal Revenue Code (IRC).
Most group plans will have a monthly benefit cap based on the number of people covered and covered payroll. It is not uncommon for group plans to provide a disability income replacement of 60% to a maximum of $6,000 per month. At 60%, the $6,000 monthly benefit covers the first $10,000 of monthly income. While this will cover the full income for most employees, those with annual compensation in excess of $120,000 have income that is not protected against loss in the event of a disability claim.
To remedy this, employers can stack individual disability contracts on top of the group benefit to provide a combined 60% income replacement of the full executive income. In most situations with multiple impacted employees, employers can get guarantee issue for the supplemental coverage, eliminating the need for medical underwriting.
Group life insurance
Most group life plans are provided as a multiple of salary, but are also capped. Caps are often a fraction of an executive salary instead of a multiple. In the event of the death of an executive employee, the amount of life insurance needed to provide a reasonable level of income replacement for the surviving spouse is between five and 10 times annual income. A plan that provides one times salary to a cap of $50,000 or $100,000 will not provide a full multiple of salary for a higher compensated employee.
To remedy this, we typically stack an individual term life contract on top of the group plan to provide a comparable or slightly higher multiple of income for the executive group. Social insurance survivor benefits have a nominal impact on an executive’s income replacement needs.
Most employers offer a 401(k) qualified retirement plan with some form of employer match. Depending on the results of the annual discrimination testing, the plan may or may not allow a highly compensated employee the ability to set aside the $18,500 IRC maximum elective contribution. However, even if executive level employees make the $18,500 statutory maximum contribution, that contribution may still fall short of what they need to be funding as a percentage of their gross income to provide a reasonable income replacement in retirement.
A plan sponsor can take advantage of one of the Safe Harbor contribution arrangements to eliminate the annual discrimination test. However, Safe Harbor requires full and immediate vesting of employer contributions and may require a level of contributions in excess of what the employer may be able to justify.
To remedy the shortfall for highly compensated employees, we suggest that employers sponsor a supplemental retirement plan that will allow their highly compensated employees (HCEs) the opportunity to save 15% of their full gross income. The 15% reflects the minimum percentage of income that a non-highly compensated employee (NHCE) can elect. NHCEs can contribute the full $18,500, which is just a little over 15% of a $120,000 income, and could be as much as 100% of compensation since a person earning $18,500 could defer 100% of their income.
Retention benefits are designed to provide tax-free leverage for executives to cover what would otherwise be after-tax expenses. Due to higher income levels and our progressive tax structure, these benefits have become highly prized by executives and are a great retention tool.
Long-term care insurance
Long-term care insurance helps married couples protect retirement income from spend-down to cover expensive long-term care services for a spouse impacted by a severe disability. Long-term care services can run anywhere from $3,000 a month for minimal, in-home care services to $15,000 a month for memory care facilities.
An employer can, on a discriminatory basis for select employees, pay premiums for long-term care insurance that covers both the executives and their spouses. The premiums are a tax deductible expense to the employer, and are not treated as income to the executive if the company is a regular C-Corp, regardless of stock ownership. If the covered employee is a 2% or greater shareholder in a tax pass through entity (S-Corp, LLC, Partnership or Proprietorship), then the premiums are treated as taxable to the employee. However, the employee can take an above-the-line deduction on their personal Form 1040, up to certain IRC age-based limits.
Premiums can be paid in full in as little as 10 years so that the executive winds up with a fully funded long-term care plan with no post-retirement premiums to pay.
Insured executive medical reimbursement plans
While employers cannot discriminate in how they fund employer-sponsored health plans, employers can provide fully insured medical reimbursement arrangements on a discriminatory basis.
Plans typically provide for reimbursement of all Section 213 eligible medical related expenses — the same as those that would be covered under a flexible spending account (FSA) or a health savings account (HSA). The plan limits are usually set high enough to cover most anticipated needs, and well in excess of FSA or HSA limits. Please note that participation in an insured medical reimbursement plan would preclude the executive’s ability to fund an HSA.
In addition to these executive level benefits, other benefit programs can include:
For more information about executive compensation and other employee benefit issues, please contact us.
In the ongoing battle to contain costs, employers are always looking for tools, old and new, to help keep their healthcare spending in check. One approach is healthcare consumerism — but too often consumerism is discussed as just another plan design option and many employers are hesitant to implement this cost-saving strategy.
Health plan benchmarking is an essential part of your strategic plan, for two important reasons:
What are some of the critical decisions you must make when designing your organization’s health plan?
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