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Staff Retention Benefits

Staff Retention – Preferred Compensation Plan

One of the methods used by employers to retain the services of key employees is ‘Preferred Compensation’. The object of a preferred compensation plan is to provide a benefit for key employees during employment, in return for the rendering of services for a certain period of time, for example, after 5 years of completed service, (a type of restraint of trade agreement).

The Process

  1. A service agreement is entered into between employer and employee whereby the employer promises a benefit to the employee, which will benefit the employee after completing say, 5 or 10 years of service.
  2. The employer undertakes to increase the employee’s remuneration by a certain amount every month, and in terms of the service agreement, the after tax money is used to fund an endowment policy taken out by the employer on the employee’s life. (See taxation example below).
  3. The policy is immediately ceded to the employer, as security, until the end of the agreed period.
  4. At the end of the agreed period the policy will mature, at which time both the employer and employee will have fulfilled the requirements of the service agreement.
  5. The employer then cancels the security session, and the employee can deal with the policy as they wish. – One of their options is to cash in the policy, or to allow the policy to automatically continue, or they may wish to make periodic cash withdrawals.
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Salary increase is determined according to the following formula:

Salary increase = premium ÷ (1-marginal tax rate)

Example:

If the employer and employee agree that the premium on the policy will be R1000 per month, and the employee’s marginal tax rate is 40%, the employee’s salary must be increased by the following amount:

Salary increase =  R1000 ÷ (1 – 0,4)

=  R1 000 ÷ (0,6)

R1 667 per month

Tax Implications:

-For the Employer

The employer can deduct the increase in remuneration to the employee in terms of the provisions of section 11(a) of the Income tax Act. The employer does not pay the premiums and does not qualify for tax deduction in respect of the payment thereof. The policy is not regarded as a company-owned policy and the provisions of section 11(w) do not come into play.

-For the Employee

The increase in remuneration is taxable in the hands of the employee. On maturity of the policy proceeds are tax-free in the hands of the employee. Any periodic withdrawals taken by the employee are also tax-free. As the policy pays out the ‘original beneficial owner’ of the policy, the gain will be disregarded for capital gains tax purposes.

Estate duty

The policy will form deemed property in the employees estate in the event of death. As policy proceeds are recoverable by the employer (to whom the policy is ceded), the employer is liable for the estate duty attracted by the policy (section 11(a) (i) of Estate Duty Act.