Business Insurance | Use Preferred Compensation To Retain Top Staff
Here’s an interesting twist to the “carrot and the stick” principle when it comes to business insurance…It’s called “preferred compensation” and when it comes to insurancesolutions, it might make a lot of sense in your business! So what’s the purpose of preferred compensation then?
To keep valuable staff in your company…that’s it!
In order to get a fat payout at the end of the agreement, the employee must “stick” around. If he or she resigns before the time specified in the service agreement (usually 5 years) they forfeit the fat payout. So how does preferred compensation work?
Five simple steps: The employer and employee enter into a service agreement. The employer agrees to increase the employee’s salary with an amount each which is sufficient to pay the monthly contribution towards an endowment policy. The employee agrees to remain with the company for the term of the service agreement. Why? Because the employee is expecting a tax-free amount to be paid to them at the end of the agreement.
The employer then uses this after tax increase to purchase the endowment. The employee is owner and life insured on the endowment policy.
The employee then cedes the policy back to the employer as security in order to fulfil the conditions of the service agreement On the maturity of this endowment policy (minimum of 5 years), and assuming both parties have fulfilled their end of the service agreement, the employer cancels the cession and the employee gets to enjoy the proceeds. Now remember that the employer carried the cost of the tax in order to offer this to the employee. The employer increased the employee’s salary with enough to take care of the extra tax that the employee will end up paying. It didn’t hurt the employees pocket one iota. The employee also gets to enjoy the proceeds tax-free if he or she sticks around.
If the employee resigns before the end of the service agreement, then the employer gets to pocket the proceeds tax-free or use them to fund similar benefits for other staff-members.
So how does the employer benefit from increasing the employee’s salary? The employer increases the employee’s taxable salary in order to pay for the endowment. The increase in salary is deductible in terms of section 11(a) of the Income Tax Act. (The salary increase is an expense incurred in the production of income for the employer).
Now if this had been a “company owned” policy, the premiums payable would be tax deductible but this would result in the proceeds being taxed.
In this instance the policy is not owned by the company, but rather by the employee, which makes the proceeds completely tax-free to either party. So how do I calculate the salary increase for the employee?
Firstly the employer and employee need to agree on how much to invest. Most endowments nowadays have a minimum monthly contribution of R500 so don’t count on spending any less than this. Let’s assume that the employee negotiates an investment of R1, 000 a month. The next step is to determine the marginal rate of tax. The minimum marginal rate is 18% while the maximum rate is 40%. In the case of Steve, a top performing salesman, he pays tax at the highest rate of 40%. This is how his increase would be calculated: Salary increase = monthly premium divided by (1 – marginal tax rate) Salary increase = R1, 000 divided by (1 – 0, 4) Salary increase = R1, 000 divided by (0, 6) Salary increase = R1, 667 per month R1, 000 a month is spent on the endowment while R667 is spent on paying the tax! What would happen if the employee died during the period of the service agreement?
This policy is owned by the employee. This amount would be owed to the employee’s estate in the event of his or her death. This policy would be seen as “deemed property” in the employees estate, but because there is a cession to the employer (Who will now get the proceeds); the employer is therefore liable for the estate duty payable. Warren Basel Independent Financial Planner Tel: 011 481 1000 Fax: 086 651 3343 Cell: 082 490 5182 E-Mail: warrenb@oraclebrokers.com E-Mail 2: warren@phantasia.co.za www.insurancebrokersa.com www.oraclebrokers.com
