Putting “Untouchable” Bonding Money To Work For a Contractor’s Retirement

Contractors are frequently engaged in business activities that require surety bonds as well as mandatory business assets to back those bonds. In such situations, you may have the opportunity to put a portion of those assets to work...for the exclusive benefit of the business owner...and potentially enhance the retirement and insurance “perks” he/she currently derive from their business. The plan providing these benefits is structured to assure the bonding provider that its financial interests will continue to be protected. In fact, the life insurance element of the plan will offer them added security probably not present in the current arrangement.

Generally, the assets the business must maintain on its business books for bonding purposes are so-called “quick” assets. This means it must be in a form that is convertible to cash within seventy-two hours. Acceptable asset types may include cash on deposit, certificates of deposit, and money market funds. Of course, the conservative nature of these types of investments means that they produce correspondingly low returns. In today’s economic environment, the business may be doing well to realize a 1.5% after-tax return. But, does it have to be this way? Is it possible to satisfy bonding requirements and, at the same time, put those assets to work for the owner’s retirement at a higher effective rate of return?

Lincoln Financial offers a unique plan called LifeComp® DollarFlex that can enable the business owner to take personal advantage of business-owned bonding assets. It employs an interest or market-sensitive universal life insurance policy that is jointly owned between the business and the business owner. The business pays the policy’s premium from the bonding asset and then contractually owns the policy’s potential cash values to the extent of that premium. Consequently, an equivalent asset remains on the business balance sheet for bonding purposes. In addition, the business is named beneficiary for a specified portion of the policy’s income tax free death benefit. This death benefit could provide a dramatic boost to the business’ balance sheet if the owner dies during his/her working years. It is also an aspect of the plan that will provide added assurance to the bonding provider.

As the plan participant, the business owner contractually owns any policy cash values in excess of those owned by the company. And, the owner names a personal beneficiary for the income tax free death benefit over and above that which will be paid to the business. Generally, the plan is designed and funded to provide the business owner with potential cash values sufficient to supplement retirement income for a specified number of years while maintaining a significant death benefit for life.

As mentioned, the business uses its bonding asset as the source for all policy premiums. The business owner pays no portion of the policy’s premium with personal dollars...and the business uses no current earnings. However, the IRS will treat (for income tax purposes) the premium paid by the business as a below market loan to the business owner. As such, he/she will have to pay interest on the loan each year at the short-term blended Applicable Federal Rate. The business, in its role as “lender”, will have to report the loan interest payment as income. But, if the business owner takes a salary bonus to pay the interest, the arrangement will result in a zero net cost for the business since it will have a salary expense deduction to fully offset its loan interest income. And, the business owner’s only out-of-pocket expenses will be the payroll tax on the bonused amounts.

At retirement, the business will call the premium payment loan. Since it has always owned the policy’s cash values to the extent of its premium payments, it simply withdraws those values from the policy and the loan is paid. Consequently, the original bonding asset, which never left the business’ balance sheet, is converted back to cash at the business owner’s retirement and, if appropriate, placed back into the original investment vehicle. At that point, the retired owner fully owns the policy and its remaining cash values from which he/she may begin a series of withdrawals to supplement other retirement income.

Lincoln Financial’s LifeComp® system tracks the plan from start to finish. It offers monthly accounting reports to help the business’ bookkeeper accurately reflect the plan on the company’s books and payroll and assure that the proper interest rate is applied to the ongoing “loan”. Equity reports (on demand) will reassure bonding providers that the business asset is both present and “real”. Automatic re-evaluations of the policy’s performance each year will determine if the plan is on target to meet the original plan objectives. If needed, re-proposals can be requested to reflect changes to keep plan on objective. These comprehensive accounting and administrative services are key to the plan’s ultimate success.

Obviously, no plan of this type should be undertaken without the prior approval of the bonding provider. With their blessing, however, LifeComp®’s DollarFlex plan design and service system can help the business owner personally benefit from his/her business’ “untouchable” bonding asset!

Lincoln holds an U.S. Patent on The Lincoln LifeComp® Suite which is offered exclusively by LifeComp® Enrolled Producers. Any Lincoln Producer may become an enrolled producer by attending one of LifeComp®’s Introductory WebEx seminars which are held throughout the year. For more information, contact LifeComp® at lifecomp@lfd.com.