21. Salary Continuation

In a Salary Continuation Plan the employer agrees to extend the employee's salary, either partially or wholly, past the employee's retirement date. This plan enables the employee to keep his or her present income at its current level and still accumulate future retirement benefits. The future benefits will be received after retirement when the employee will probably be in a lower income tax bracket.

A Salary Continuation Plan is a contractual arrangement between an employee and an employer in which the employer agrees to continue the employee's salary. The employee usually receives this continued amount in monthly payments after retirement for an agreed upon period of time. A Salary Continuation Plan generally provides that if the employee dies before receiving the full amount of his or her benefits, the remaining amount will be paid to the employee's beneficiary or estate. Most plans also include provision for a pre-retirement death benefit, as well as benefits to be paid if the employee becomes permanently and totally disabled.

Salary Continuation Plans are attractive for several reasons. First, the plan will aid in recruiting and retaining highly qualified, productive, key employees by permitting these employees to build up an additional source of retirement funds without adverse tax consequences. This benefit is especially important in a relatively small company that leans heavily upon the talents of a few executives. Additionally, many plans provide that an employee forfeits all future benefit payments by voluntarily leaving the employer or by working for a competing company after retirement. Since the employee will lose all plan benefits by leaving the benefit-providing employer, he or she has a vested interest in remaining.

A second attractive point is that a Salary Continuation Plan may discriminate among the employees. The employer thus may choose which valuable employees will participate in the plan and may vary the amounts of compensation to be continued past retirement among the participating employees. A Salary Continuation Plan is also relatively easy to administer since it is not subject to nearly as many ERISA requirements as is a qualified plan that must cover all employees.

Thirdly, since the employer is usually the owner and beneficiary of any insurance policies purchased in connection with this plan, the employer may borrow against the cash values of the policies to meet business emergencies.

An ideal way for the employer to accumulate the funds needed to meet the obligations of a Salary Continuation Plan is to purchase a life insurance policy on each employee involved in the plan. When salary continuation benefits become payable to the employee, the employer can either pay the benefit out of available cash and be reimbursed by the death benefit at the employee's death, or the employer can borrow against the policy's cash value to meet its obligations to the employee. By informally funding the plan with life insurance, the company is assured of completely recovering its costs, even where the employee dies or becomes disabled prior to retirement. Insurance provides that a guaranteed amount of income tax free death benefit will be paid to the company. It also provides a method for the company to accumulate cash without becoming subject to the accumulated earnings tax. In addition to the above mentioned advantages to the employer, a Salary Continuation Plan provides a participating employee with supplemental retirement income. Knowing that this income source exists will probably increase the employee's loyalty to the company and may pave the road to an early retirement if that is desired.

TAX CONSEQUENCES OF A SALARY CONTINUATION PLAN UTILIZING LIFE INSURANCE


To the Corporation:

The employer does not receive a tax deduction for the premiums paid on the life insurance policies since the corporation is the beneficiary of those policies. The employer usually does receive an income tax deduction for an ordinary and necessary business expense in the years that the salary continuation benefits are paid to the employee. If the employer chooses to totally surrender the policy, the difference between the cash received and the premiums paid by the employer is taxed as ordinary income. If the employer does not surrender the policy, but rather keeps it in force, the employer receives the death benefit income tax free at the employee's death. To the Employee:

As long as the employee has no "incidents of ownership" in the life insurance policy, he or she receives no taxable income prior to retirement. After retirement, the employee is taxed on the salary continuation benefits as they are received at ordinary income rates. Additionally, where the employee dies before receiving his or her full benefit amount, the present value of the benefits remaining to be paid is included in the employee's gross estate for estate tax purposes.

Tax reference verification 1-800-829-1040

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