Ep 280: REBA can be your best benefit!

Welcome to this week's episode.

Last week we talked about some life insurance basics and we talked about some advanced life insurance topics.

Since this is Life Insurance Awareness Month, this month I'm going to give you a hack, or I'm going to give you a tip or way that you, as a business owner can use life insurance to increase your employee retention.

So I hope that you enjoy this episode.

Welcome to the weekly Wealth Podcast.

I am certified financial planner David Chudick.

This podcast and my wealth management practice are both designed to help the mass affluent to live better lives by how they handle their money.

We talk about financial strategies, prosperous mindsets, and simply how to build true wealth.

So come on and let's enjoy this journey together.

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All right, so let's get into the episode.

Picture this.

You run a business.

You have one person.

They're not a partner.

They're not family.

They're an employee, an incredibly valuable team member who makes the whole place run.

They know where the proverbial bodies are buried.

The clients trust them more than they trust you some days.

And if they walked out the door tomorrow, you'd feel it in your revenue within a month and your stress level would go up.

Now picture a recruiter calls them a better title, maybe 10% more money and a signing bonus.

What do you do?

Most owners do the only thing they know how to do.

They counter, they throw a raise at it.

And here's the problem.

A raise is a number.

And someone, especially a bigger company, maybe a large corporation, can always beat a number.

What they needed wasn't a bigger number.

They needed a reason to stay that a bigger number somewhere else couldn't undo.

So today we're talking about one of the most underused tools in a business owner's toolkit for keeping the people they can't afford to lose.

And the two very different ways you can set it up, one of which barely works at all and the other which actually has teeth.

This is the weekly well podcast.

I'm David Chudick.

And this is what nobody tells you about retention.

But here's our quick ask before we dive in.

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All right, business owners.

So here's the thing.

Think about the tools that were built for retaining people.

Most of them were built to retain everyone.

So here's the thing about retaining a key employee.

Most of the tools were built for retaining everyone, or mostly everybody, but not like one or two people.

So think about the 401k or the profit sharing plan.

Those are qualified plans, which means the IRS says you have to file a Form 5500 and it has rules about who has to be included.

You just can't say that this benefit is for Sarah and nobody else.

Qualified plans have to pass non discrimination testing, which broadly means if you want to do something generous for your top performer, you often have to do something at least somewhat generous for everyone too.

That's expensive, it's slow to build meaningful value, and honestly, it doesn't feel personal.

Sara doesn't feel retained by a 401k match that everyone gets in the building.

So what do most owners do instead?

They give a raise or a one time cash bonus.

Which brings us to today's topic, because there's a version of this that costs about the same amount as a bonus, but does something that a bonus alone never can do.

So there's something out there called a Section 162 bonus plan.

I bet you never heard of it.

And it's named after that part of the tax code that makes the bonus deductible to the business.

But forget the code section.

Here's what it actually looks like in plain English.

The company pays a bonus to a key employee.

Instead of that bonus just landing in their checking account, the employees use it to buy permanent life insurance.

On their own life.

They own the policy.

It's theirs, not the company's.

Inside the policy, cash value builds over time.

And on top of that, there's a death benefit protecting their family if something happens to them.

Now here's why business owners like this.

There's no IRS approval process, no plan document filing, no non, non discrimination testing.

Remember that form 5500 that I mentioned a few minutes ago?

Yeah.

In addition to filling that out, you also have to typically pay a third party Administrator to fill it out.

You can do this for one employee and nobody else.

And nobody's going to tell you that's illegal because it isn't.

It's just a bonus.

What the employee does with that bonus is what makes it an executive bonus plan instead of just a bonus.

Let's run through some other options quickly because the comparison is what makes us click.

What about deferred compensation?

That's where the company promises to pay the employee later.

Sounds appealing, but that money technically still belongs to the company until it's paid out.

If the business hits hard times or gets sued, that promised money is exposed to those creditors.

Okay, so if the business hits hard times or gets sued, your deferred competency is exposed to creditors.

That's a little bit scary, right?

The employee is just an unsecured creditor in line with everyone else.

Now, a qualified plan like we covered is a broad based by law and slow to build meaningful value for any one person.

What about a straight cash bonus with no strings attached?

It gets spent, vacation, new truck, whatever.

There's nothing left in six months.

And there's no reason for that employee to think twice before taking the next call from a recruiter.

Now, an executive bonus is deductible to the company, just like a cash bonus.

It's completely selective.

So you, as the owner, as the manager, can pick who gets it.

And it builds something that actually exists a year, five years, 10 years down the road.

So if your business depends on one or two people, that's not a staffing question, it's a valuation risk.

Find out where your business stands with a free saleability score assessment by going to www.weeklywealthpodcast.com/.

So let's put real numbers on this.

So it's not just an abstract concept.

Say you want to bonus a key employee $10,000 a year to fund this.

Here's the wrinkle.

The bonus is taxable income to the employee, same as any other bonus.

So if you hand them 10,000, they might only net around 7,000 after taxes.

And now the policy isn't getting funded the way that you intended.

So that is where a lot of owners make a mistake or.

Or where the plan gets structured lazily.

The fix is what's called the double bonus or the gross up.

You bonus enough extra to cover the employee's tax liability on the whole thing.

So the full amount you intended actually makes it into the policy.

So here's your rule of thumb.

If you want $10,000 lending in the policy, you're likely bonusing closer to $13,000 or $14,000 once you gross up for taxes.

The exact number depends on the employee's tax bracket.

You can work with your CPA or your tax preparer to help you calculations, but this is exactly the kind of detail that separates a plan that works from one that quietly underperforms for 10 years without anybody noticing.

It's a five minute conversation with the right advisor.

And it's worth having before the first bonus check goes out, not after.

So let's talk first about the version of this plan most business owners actually stumble into.

First, because it's the simplest possible version and it's worth understanding before we get to the better version.

Some owners skip the formal structure entirely.

They just pay the bonus and have a conversation.

Hey, I'm giving you this bonus.

I'd really like you to think about putting it towards a life insurance policy.

No plan document, no contract, no paperwork tying the bonus to the insurance at all.

That is sometimes called a naked bonus plan.

Yep, keep your jokes to yourself.

And the name is fitting because it has no protection built in whatsoever.

So here's why the owners like it.

It's the simplicity.

There's zero legal costs, zero administration.

And it can happen in a simple compensation conversation.

For a very small business with one key person and a lot of informal trust, that simplicity is genuinely appealing.

But here's the problem with it.

There's nothing stopping that employee from taking the bonus and never buying the policy at all and spending on something else entirely.

And even if they do buy the policy, like you discussed, there's no vest, no clawback, there's nothing.

They can surrender that policy and walk out the door with the cash value the very next day if there is some cash value.

The same day that they hand in their resignation.

So retention is the actual goal, and it usually is.

And you wouldn't be doing any of this.

You want the version with teeth.

That's called a restrictive endorsement bonus arrangement or rba.

Here's how that fixes the problem.

The company still pays the bonus.

The employee still owns the policy, but the company places a restrictive endorsement on that policy.

Essentially a temporary hold that limits the employee's access to the cash value for a set number of years.

Maybe it releases in thirds over five years.

Maybe it's all or nothing at year three.

That's a design choice.

If the employee leaves before the endorsement lifts, the the company restriction stays in place, or in some structures, the company can recover what it's contributed.

The employee still technically owns the policy.

The whole time which keeps it from turning into a qualified plans with all the rules that come with it.

But now there's an actual reason to stay that just isn't a handshake.

So let me say this plainly because I don't like hype around insurance products.

Trust isn't a plan if retention actually matters for your business.

The naked version isn't worth the paper it's not written on.

The RIBA is a little more has a little bit more setup, but it's difference between hoping someone stays and giving them an actual reason to stay.

So this isn't for every employee.

It's not a broad based benefit strategy.

This is for the one or two people where if you're honest with yourself, the business would really take a hit if they leave.

It works best when the business doesn't already have an appetite for a qualified plan or has one, but wants something additional and more targeted for the people who matter most.

And here's where we'll tie back to something that I talk a lot about this show.

This is who, not how decision.

The question isn't how do I personally design a bonus plan, it's who do I bring in to structure this correctly so it actually holds up?

This sits right at the intersection of compensation strategy, tax treatment, and insurance design.

And getting any one of those three wrong completely breaks the whole thing.

So if today's episode had you thinking about one or two people your business genuinely can't afford to lose, that's not just a people question, it's a value question.

A business that depends entirely on one or two irreplaceable people is by definition harder to sell.

So if you want to look at what it might be like for you to structure a plan like this, let's book a free 20 minute vision call.

We can talk through whether an executive bonus plan and which version of it makes sense for your business.

Go to www.weeklywealthpodcast.com vision.

That's www.weeklywealthpodcast.com that's it for this week's everybody.

I'm David Chuddick.

Thanks for listening and I'll see you next week.

The information presented on this podcast is for general educational purposes only and does not constitute financial, investment, legal or tax advice.

Parallel Financial is registered with the U.S. securities and Exchange Commission as a registered Investment Advisor.

Registration does not imply a certain level of skill or training, nor does it constitute an endorsement by the sec.

All investing involves risk, including the potential loss of principal.

Please consult a qualified financial professional before making any financial decisions.

And here is your bonus content for this week.

As an owner, as a leader, doesn't it make sense to do what you can to retain the people in your life?

Not necessarily that make you a lot of money, but the people that make make your life easier, the people that take the things off of you that just drive you nuts and that give you stress.

That is why a great retention plan and some of the things we talked about today may may be part of your retention plan.

But that is why a retention plan is something that you can consider for your business.

We always talk about money being a tool to give us better lives.

Well, if your business life, if, if your work life is less stressful, that gives you a better life.

All right, everybody.

Until next episode, I wish everybody a blessed week.

Thanks for listening.

And make sure to tell your friends.