The “ERISA Exemption Strategy” by Paul M. League, QFP—QUALIFIED FINANCIAL PLANNER
(Exclusive Owner/Manager Benefits Arising from the ERISA Collective Bargaining Exclusion)


Since the writing of the following article the value of implementing the articles discussed ERISA Exemption Strategy becomes ever more valuable..

Recent legislative action will soon see the passage of the E.F.C.A. – the Employee Free Choice Act – and with it business owners can either be proactive by aligning with a ‘business reasonable’ Union of their choosing, or having another kind of Union forced upon them due to the provisions of this Act.

As the Owner or Senior Management of a Company or Professional Practice, with 10 or more employees, you now, more than ever, have some very important questions to be asking yourself:

· Do you want to have a labor contract on ‘your terms’ or just on the ‘union’s terms’?
· Do you want to ally with a ‘business partner’ union of your choice now or perhaps be organized by an ‘adversarial’ union that will be hostile in all of your future relationships?
· Do you want to learn how to make the Employee Free Choice Act work for you and your company?

The E.F.C.A. Bill is now being modified in the Senate and is likely to pass this year.

When you couple the above with the Executive Order issued by President Obama to all Federal Government Agencies on February 6, 2009, regarding the awarding of construction (and other) government contracts that requires businesses to pay ‘union scale’ to be considered, the Strategy discussed herein takes on even greater levels of significance.

Business Owners and Professionals cannot continue to ignore this Bill or the earlier Executive Order, and the impact these will have on them.

But there are ‘silver linings’! If you would like to learn how to make these matters work FOR YOU instead of AGAINST YOU…please read on.

Pre-ERISA (1974) found many business owners and high-income professionals happily providing themselves extraordinary retirement and medical reimbursement benefits, while their rank-and-file employees had only limited benefits. ERISA, in the minds of many, misleadingly appeared to have changed all of that forever.

ERISA actually created many opportunities for progressive business owners to continue providing themselves an array of exclusive benefits, so long as they willingly formalize the employment relationship with their rank-and-file employees contractually. The reality is that the personnel policies of most businesses already incorporate many of the requirements embodied in legitimate collective bargaining arrangements.

Today’s high-income professionals and business owners are often victims of “reverse discrimination” in many ways. For example, a 401(k) contribution of $18,000 a year by Mr. Doe, a non-highly compensated employee earning $50,000 a year, represents an income tax-advantageous deferral of 36%. John’s 50-year old employer, Mr. Boss, on the other hand, who earns $500,000 a year, can also only defer $18,000 a year – representing an annual tax deferral of only 3.6%. Mr. Boss is a typical victim of ERISA “reverse discrimination.”

Employers are also more at risk today than ever before for employee legal complaints. Many employees who feel that they have been unfairly treated or sexually harassed simply contact their local trial lawyer to file suit, or they contact the Equal Employment Opportunity Commission (EEOC) to file a complaint. In either case the employer can expect a long, expensive, and exhausting challenge – one in which a “win” may actually be a loss.

A third area in which successful business owners and professionals are at risk is punitive damages resulting from lost lawsuits. Jury awards can bankrupt small business owners and high-income professionals. Many affluent employers seek ways to protect assets and earned income from adverse judgments, with the most effective technique sheltering being inside of ERISA qualified retirement plans.

While it is true that ERISA placed substantial restrictions on what employers can do for themselves, it also created opportunities. Employers who are concerned with tax-sheltering and asset-protecting as much earned income as possible, and with paying for uninsured healthcare expenses with tax-deductible earnings and profits, can still do so – and more – on an exclusive basis.

Understanding the Benefits Terrain

Misconceptions abound about establishing benefits for small businesses; namely, which benefits are subject to ERISA non-discrimination rules, and which are not.

  1. If the benefit is not a “qualified benefit” – it would not be subject to ERISA non-discrimination rules.

Example: Non-qualified Deferred Compensation Plans, Executive Bonus Plans, Split Dollar Plans, Long Term Care Plans (LTCi), Long Term Disability Plans (LTD), and IRA’s.

  1. If the benefit is a “qualified benefit” – it is fully subject to ERISA non-discrimination rules.

Example: Qualified Retirement Plans – Simple, 401(k), Profit Sharing, 412(i), other Pension plans, or health plan benefits such as a Medical Reimbursement Plan.

Qualified plan benefits allow exclusions only as defined in the Internal Revenue Code as quoted herein. Therefore, a business owner cannot establish a different qualified retirement plan for management in his own company, versus a different plan for non-management employees, unless employees are excluded by one of the five statutory allowed IRC exclusions.

Under IRC Sections 410(b) and 105(h) certain employees are able to be excluded from participation in such plans as: employer-funded retirement and medical reimbursement plans. The last of the following listed exclusions frightens many who fear outside interference of the owner’s management and control of the business. Don’t be alarmed! The issue is simply one of contract law, which when properly applied can enhance the owner’s management control and eliminate the prospect of employee legal dispute, EEOC actions and a myriad of other problems.

Exclusions listed in the two IRC Sections 410(b) and 105(h) include:

  • Part time employees working less than 1,000 hours per year
  • Employees with less than 1 year of service (retirement plans), or 3 years of service (medical reimbursement)
  • Employees under the age of 21 (retirement plans) or the age of 25 medical reimbursement plans)
  • Non-US. Citizens working outside the U.S. with no U.S. source income
  • Employees whose benefits are governed by a legitimate collective bargaining agreement

In simple terms a collective bargaining agreement should be looked at no differently than buy-sell agreements, independent contractor agreements, key man agreements, and other contracts used every day in business life. Compliant employment contracts are those prepared and negotiated pursuant to the National Labor Relations Act of 1935. This is not a new idea, but rather one that is steeped in over 70 years of solid labor and tax law. The key, however, is being compliant. Contracts must be negotiated in good faith, and at arms length under the auspices of a union representative.

Compliant Collective Bargaining Planning

Compliant employment contracts for rank-and-file employees avoid the problems referred to in common law as “adhesive” contracts. These contracts have uniformly been held to be unenforceable because management holds a dominant edge over individual non-management employees.

Compliant collective bargaining agreements, on the other hand, are enforceable by the National Labor Relations Board. The United States National Labor Policy is summarized in the National Labor Relations Act of 1935, with its primary goals being:

  • to assure continued production, uninterrupted by strikes and/or lockouts, and to promote harmony in the workplace.
  • an understanding that industrial peace is most effectively achieved through peaceful negotiation between employers and employee representatives.
  • that self-organization of employees is vital to the process and must be accomplished without employer interference, union coercion, or other unethical practices.
  • that it is the duty of the union to bargain fairly on behalf of all employees, including non-members.

Subjects for Collective Bargaining Negotiation

From a labor law standpoint the key is to understand the differences between what are “mandatory items for negotiation”, “permissible items for negotiation”, and “prohibited subjects for negotiation“.

Mandatory subjects for negotiation include: “wages, hours, and other terms and conditions of employment.”

Courts have held this language to require negotiation “for retirement and other benefits, in-plant food prices, work assignments, grievance conflict resolution procedures, safety rules and practices, contracting out work performed on the premises, monitoring of employees in the workplace, recognition of the union as the legitimate bargaining representative.”

Permissive subjects for negotiation, which are recommended, include: “any policies governing employee performance review, incentive bonus program, employee termination procedures, employee leave of absence, vacation, observed national holidays, and nepotism.”

Illegal subjects for negotiation, that must be avoided, include: “any requirement of a closed shop, preferential hiring of union members, discriminatory practices (race, national origin, sex, age, etc.), a dues check-off system, or waiving the right of the union to distribute literature on company property.”

Therefore, a legitimate ERISA qualifying exclusion, while within the purview of ERISA non-discrimination rules, avoids running afoul of them by identifying, up front, abusive practices and fully addressing and eliminating them as part of the collective bargaining process itself.

Business owners and high-income professional employers are forever seeking legitimate ways to provide special management benefits without having to include all employees, but what additional advantages can companies gain from contractually formalizing the employment relationship with their employees? Quite a lot, when examined closely as follows.

Upside of Compliant Employment Contracts

  • Enhancement of employer-employee relations.
  • Improved attraction and retention of best employees.
  • Projection by management of fair practices and equal treatment.
  • Contractually defined terms, benefits, and conditions of employment that reduce issues causing disputes.
  • Contractually defined management authority, termination policies, drug and alcohol abuse testing procedures, and conflict resolution procedures.
  • A system for annual employee performance reviews and written reprimands that support management’s defense against employee complaints and lawsuits.
  • Binding arbitration as the ultimate decision making process for employee complaints that cannot be otherwise resolved – effectively eliminating lawsuits and EEOC actions.

Downside of Compliant Employment Contracts

  • Cannot fire employees “at will” (it should be noted that employers abusing their authority to fire “at will” has led to the creation of the Equal Employment Opportunity Commission (EEOC) and many employee lawsuits. “At will” firing authority has little real value in today’s litigious environment)
  • Cannot reduce employee benefits during the contract (it should likewise be noted that although an employer cannot reduce employee benefits during the term of a collective bargaining agreement, benefits for employees are also contractually determined and not subject to be increased).
  • The primary negative to an employer is that they cannot freely outsource work being already performed by existing employees after the contract is executed.
  • Employers should expect to pay limited reasonable fees for contract negotiation expenses, plus annual consultant, intermediary, and compliance services.

Upside/Downside of Compliant Employment Contracts – A matter of one’s perspective

  • Employers recognizing the mutual benefits of formalizing the employment relationship are advised to increase the compensation of rank-and-file employees choosing to join the union by the nominal amount of their union dues (typically less than a dollar a day) to avoid participation being an economic disincentive to them.

The Exclusive Benefits to Owner/Managers of the Collective Bargaining Exclusion

In addition to the other many benefits to an employer and its employees of formalizing the employment relationship, employers are able to establish exclusive benefits for management, versus non-management employees, that do not violate the non-discrimination rules of ERISA. Some of the more popular of these benefits are as follows, with Long Term Care Insurance growing ever more popular as the public’s awareness of this largest un-funded liability continues to rise:

  • Management can establish an exclusive retirement plan for all employees not governed by the non-management employment contract.

    Retirement Plan – Typically either a safe-harbor Simple or 401(k) Retirement Plan is established for non-management employees with employer contributions being 3% of payroll pursuant to the negotiated employment contract. An executive plan for the management team can then be established to include both pension benefits such as a 412(i) plan to fund up to $170,000 a year (in 2005) retirement income benefit to the executive plus a key employee contribution Simple or 401 (k) plan that enables key management employees to each shelter up to $18,000 a year of their own money from current taxation.

  • Management can establish an exclusive medical reimbursement plan for all employees not governed by the non-management employment contract.

    Medical Reimbursement Plan – Most taxpayers never have the opportunity to deduct their uninsured healthcare costs. Under IRC Section 213 the taxpayer must first exceed 7 ½ % of adjusted gross income to begin deducting these expenses.

    Employer funded health plans under IRC Section 105 allow employers to establish plans to reimburse employees on a FICA free – Employer tax-deductible – Employee tax-free basis for these uninsured healthcare expenses.

    IRC Section 105 (h) allows employers to establish exclusive benefits for management versus non-management employees if governed by a compliant employment contract. An employer can, for example, establish one plan for non-management employees. Such a plan simply reimburses them for health insurance expenses they incur should they choose not to participate in the employer sponsored health insurance plan (as in the case of an employee who waives coverage due to being covered under their spouses employer elsewhere), subject to defined limitations that would not exceed what the employer would have contributed anyway toward the employee’s health insurance benefits. The employer can then establish a separate executive medical reimbursement plan for the management team that provides superior comprehensive reimbursement benefits. For someone in the 35% tax bracket – every dollar paid for non-deductible healthcare expenses equates to over $1.65 of earned income.

    Added Creative Uses of a Medical Reimbursement Plan:

    • Substantially raise the deductible on the underlying employer sponsored group health insurance plan (like those available via an HSA, or Health Savings Account, or other such high deductible plans), and then reimburse employees who have claims on a portion, or all of the difference between the “old, higher cost, low deductible” and the “new, lower cost, high deductible” – this eliminates the burden on the employee, shifts the risk on the differential to the employer, while substantially reducing the employers healthcare insurance costs.

    • Consider including parents and children in a director or management role to be covered by the medical reimbursement plan for management.

  • Management can establish exclusive critical illness benefits for all employees not governed by the non-management employment contract, and can use medical reimbursement plans as a means to reimburse key employees for the costs of Critical Illness insurance policies, which they purchase on a tax favorable basis.

    Critical Illness Plan – Critical Illness insurance, unlike disability coverage, is a policy that pays the “face amount” of coverage to the insured “upon diagnosis” of one of numerous life-threatening or disabling events such as heart attacks, life threatening cancer, and renal failure. It should be noted that people between the ages of 30 and 40 have over a 30% chance of a critical illness claim prior to age 65. The benefits paid are income tax free to the insured so long as the premiums were paid with “before tax” dollars.

    Added Creative Uses of a Medical Reimbursement Plan in Critical Illness Plans:

    • Medical reimbursement plans can be utilized to minimize the IRC Section 213 costs of these policies by reimbursing the insured, at yearend, for policies individually purchased and paid for at the beginning of the year (in cases where no claims are filed or paid). Premium two, in year two, is paid in a new tax year. If benefits are paid they tend to deliver a far greater value then a reimbursement on merely the premiums paid and where no claims are filled or paid.

  • Management can establish exclusive LTD, or Long Term Disability coverage for all employees not governed by the non-management employment contract.

    Long Term Disability Coverage – LTD, unlike Critical Illness, is a policy that replaces a portion of one’s lost earned income upon proof of the insured’s inability to continue working or loss of income. Some policies replace income based on one’s “own occupation” whereas other policies reimburse the insured if unable to work at all.

    Disability insurance policies generally reimburse 50-70% of one’s lost earned income. The benefit is tax free if premiums were paid with after-tax dollars, and if paid with tax-deductible dollars, the benefit is taxable upon receipt.

    Although Long Term Disability is not subject to the ERISA non-discrimination rules, many supplemental employer-funded salary continuation plans are often challenged when the only employees included are stockholders. The usual result is that the payments are deemed to be dividends. A safer plan is one in which all employees, other than those governed by a collective bargaining agreement, are included, another affordable and cost-effective benefit made available through the collective bargaining exclusion.

  • Management can establish exclusive Long Term Care Insurance coverage.

    Long Term Care Insurance (LTCi) Protection – LTCi protection is uniquely allowed to be funded with income tax deductible dollars and still enjoy a tax-free benefit. Long Term Care insurance is not subject to the ERISA non-discrimination rules and can be funded by the employer for designated key employees only. A valuable planning strategy for business owners is to include parents or older children in a director or management role to be covered by employer-funded LTCi plans.

  • Management can establish exclusive Split Dollar, Non-Qualified Deferred Comp, & Executive Bonus Plans.

    Split Dollar & Non-Qualified Deferred Compensation Plans – Non-Profit Corporations and Business owners operating as non-public “C” Corporations that are not deemed to be Personal Service Corporations enjoy special income tax brackets that enable them to utilize retained earnings and profits on a favorable tax basis to fund designated key-executive benefits such as Split Dollar life insurance and Non-Qualified Deferred Compensation Plans on an “exclusive basis.” These plans are not subject to the ERISA non-discrimination rules.

    • Split Dollar plans enable businesses to fund special, exclusive life insurance plans for key employees until retirement.

      1.) Endorsement Split Dollar Plans are life insurance contracts owned by the business on the lives of key employees typically established and totally funded by the business, with the greater of cash surrender value or premiums paid inuring to the business and the excess death benefit each year inuring to the key employee and payable to his or her designated beneficiary.

      Endorsement Split Dollar Plans are often used in conjunction with Non-Qualified Deferred Compensation Plans to fund a future retirement benefit while providing current life insurance benefits to designated beneficiaries of key employees prior to retirement.

      2.) Collateral Assignment Split Dollar Plans, on the other hand, are life insurance contracts owned by either the insured or a trust created by the insured, with an assignment by the key employee to the corporation of an interest in the policy.

    • One valuable technique in Non-Qualified Deferred Compensation Planning is for the employer to accumulate cash surrender values until the employee retires and then exchange the life policy for a single premium immediate annuity on a tax free basis. The income paid to the company from the annuity is used to fund the retirement benefit to the now-retired employee. A substantial portion of the payment from the annuity is a return of basis, which creates a tax shelter for the employer against other earnings and profits each year.

In light of historic abuses in both Split Dollar & Non-Qualified Deferred Compensation Plans, we now have clear, established guidelines to follow that eliminate IRS challenges when plans are prepared and administered compliantly.

Executive Section 162 Bonus Plans utilizing insurance contracts, owned by the key executive, but funded via an annual company bonus that is taxed through to the key executive.

What Happens When It Becomes Time To Retire or Otherwise Exit Such Plans?

Owner exit strategies are very much the same whether employees are governed by an employment contract or not. Typically sales of closely held businesses and professional practices are “asset sales” versus “entity sales” because buyers do not want to find themselves obligated to hidden liabilities of the seller. In an asset sale the “trade or business” is sold and the entity typically liquidated. In regards to the collective bargaining agreement between the “selling entity” and the “collective bargaining representative for the employees” – the employment contract simply terminates.

Who Is The Ideal Candidate for Such a Plan?

Employers are best served, when considering such a plan, to have a Qualified Financial Planner ( conduct an employee benefits cost analysis to determine exactly the current flow of resource dollars between them and their employees. The heart of good benefits planning is proper fiscal analysis to see exactly what you are now doing versus potential options and opportunities that may improve the picture specifically as it relates to owners and their key managerial personnel.

Certain benefits are a “given” under collective bargaining agreements – primarily retirement and health benefits. Additionally, collective bargaining agreements always provide for defined vacation policies and the observance of specified national holidays. Therefore, a responsible employer, who is already providing its employees with these basic benefits should not find formalizing the employment relationship via collective bargaining to be a great leap in exchange for achieving exclusively enhanced owner/manager benefits. Others, not offering such basic benefits, are not quite as ideal candidates to take advantage of this valuable exclusion from the ERISA non-discrimination rules for benefits funding. Unions typically seek only fair practices and treatment for the employees they represent, having no interest in causing unrest or interfering with management of the business. What most employers find is that the outcome of legitimate collective bargaining almost always promotes increased harmony and productivity in the workplace.

In light of the foregoing, the best candidates are those who are self-employed business owners and high-income professionals sharing most of the following characteristics:

  • Over age 50
  • Earning over $250,000 a year
  • Limited financial debt
  • Concerned with asset protection
  • Concerned with saving for retirement
  • Concerned with uninsured health costs
  • With 3 or more employees per owner/key management person
  • Unable to afford, or not inclined to provide, the same level of benefits for all employees


The overlooked collective bargaining exclusion has the potential to produce rather rich benefits for management having the right profile and mindset.

What we have discovered herein is that wrongly perceived draconian ERISA ’74 restrictions have within them “life building DNA strains” that, when properly utilized, have the unique ability to cure owner/manager problems by actually improving upon Pre-ERISA ’74 executive benefits and also striking an improved and effective balance between the needs of management and employees.


Disclaimer: The material discussed herein is meant for general illustration or informational purposes only and is not to be construed as investment advice. Although the information has been gathered from sources believed to be reliable, it is not guaranteed. Please note that individual situations can vary; therefore, the information contained herein should be relied upon only when coordinated with individual professional advice. We are not licensed for and therefore do not provide tax or legal advice.

About the Author: Paul M. League, QFP — QUALIFIED FINANCIAL PLANNER, is the Founding Principal of League Financial & Insurance Services (, which is a privately held company, established in 1984, since located in Palm Desert, CA. Paul and his company specialize in assisting clients to create, expand & preserve assets “…in a league of our own.” Contact Information: Paul M. League, P.O. Box 11800, Palm Desert, CA 92255-1800; T: 800.482.5347; © Paul M. League. All rights reserved.

Acknowledgements: Claude B. Bass, J.D.

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