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advanced markets groupNon-Qualified Deferred Compensation

do you work with business owners who:• manage family-owned, or other small closely held businesses or startups?

• want long-term commitments from non-owner key employees without sharing ownership of the business with the employees?

• want to retain 100% of the stock and control of the business?

A PHANTOM STOCK PLAN is a type of non-qualified deferred compensation benefit that provides key employees of a company with the economic benefits of business ownership, without actual ownership. In this plan, key employees are rewarded with performance-based compensation which is driven by the financial success of the business. As the value of the business increases, so does the potential for extra compensation to the plan participants. At the same time, the business owner avoids the transfer of equity to a key employee and eliminates the inherent conflicts that can occur with minority interests in a closely held business.

Phantom Stock gets its name from the fact that the amount of compensation received by a plan participant is measured by the value of a theoretical block of stock. The idea is to give the employee a financial reward as if he or she had actually received a block of stock in a corporation or an equity interest in a limited liability company or partnership.

Phantom Stock is offered pursuant to a written plan and covers one or more employees. A key element of the plan is the formula for valuing the business, which will determine the participant’s benefits under the plan. A formula may be as simple as measuring the change in net equity on the balance sheet from year to year. Or it may be as complex as needed to encourage behavior which fosters the results desired by the company. For this reason, a measure of the change in value of the business is often based on the earnings of the company.

How does a phantom stock plan work?The employer establishes a bookkeeping account for the employee. The employer credits the employee with a number of “units”. Each unit represents a share of the employer’s stock. The stock’s value becomes a measuring device for the plan. (When used with a non-corporate employer, the business “equity” credited to the employee is referred to as a “participant” unit). Each year the employer awards “units” to the key employee. Upon termination of employment due to retirement, disability, or other triggers under the plan, the employee receives a dollar amount equal to the amount of appreciation in the units awarded. In some Phantom Stock Plans, the employee will not only receive the appreciation, but will also receive the value of the underlying units. The employee does not own the units in the plan and any amounts credited to the employee remain subject to forfeiture until paid out. Upon termination of employment, payment can be made in a lump sum or over a period of years depending upon the terms of the written plan.

SunSolutions for LifeSM Phantom Stock Plan

Not FDIC/NCUA INsUreD • MAy lose vAlUe • No bANk/CreDIt UNIoN gUArANtee • Not A DeposIt • Not INsUreD by ANy FeDerAl goverNMeNt AgeNCy

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mechanics of planDuring the accumulation period, the key employee’s account is credited with amounts equal to the earnings of the company attributable to the units held. For instance, if the company earns 10% for the year, that amount will be credited to the employee’s account and will be reflected in the value of the units. The key employee has no rights in the account other than as an unsecured creditor.

How the account worksEmployee A is credited with a $30,000 award in Year 1. The value placed on each unit for accounting purposes is $100/unit. Therefore, Employee A receives 300 units in Year 1. Earnings for the company are assumed to be 10% for the first year of the Plan. (Actual earnings or a declared award by the employer.)

At the end of Year 1, the value of the units is increased to $110 per unit (100 x 10%).

The plan is projected to continue for a total of 15 years with the employer crediting $15,000/yr growing at 10%. At the end of year 15, the hypothetical account will have grown to $586,905. At that point, under the terms of the deferred compensation agreement, the key employee may take a lump sum or spread the payments over time as specified in the agreement. After taxes (at 40%) the lump sum would be $352,143 or a 10 year payout would be $52,100 per year.

Funding the planThere is a complete separation between the funding of the Plan and the measurement of benefits under the Plan.

The Phantom Stock Plan itself is the measure of the benefits under the Plan. The actual funding is done by means of tax deferred life insurance contracts.

The employer purchases key person life insurance policies on the lives of the participants and funds those policies in order to meet the promises to employees under the Phantom Stock Plan.

plan Year 1

300 units @ $100 Earnings @10%

300 units @ $110

= $30,000 + 3,000 = $33,000

plan Year 2

$15,000 award @$ 110 units

Carry forward from Year 1 Total

Earnings for Year 2 are again credited at 10% New value per share (110 + 11)

= 136.36 units 300.00 = 436.36 units = $ 11 per unit = $ 121 per unit

Balance of employee a’s account at end of plan Year 2

436.36 units x $121 = $52,800

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This information contains references to concepts that have significant legal, accounting, and tax implications. It is not intended as legal, accounting, or tax advice. Clients should consult with their own financial and tax advisor regarding the application of these concepts to any particular situation.All guarantees are based on the claims-paying ability of the issuing company, Sun Life Assurance Company of Canada (Wellesley Hills, MA), Sun Life Assurance Company of Canada (U.S.) (Wellesley Hills, MA) or, in New York, Sun Life Insurance and Annuity Company of New York (New York, NY). All are members of the Sun Life Financial group of companies.

© 2009 Sun Life Assurance Company of Canada. All rights reserved. Sun Life Financial and the globe symbol are registered trademarks of Sun Life Assurance Company of Canada.XMSD 44/606 (Exp. 03/10) SLPC 17950 (09/07)

For more information, please contact your sun Life Financial representative.

In this particular case, for a 50 year old female executive, the business purchased a $500,000 Sun Executive Variable Universal Life Policy with an increasing death benefit. It was funded at $20,100 annually for the 15 year accumulation period. That policy, returning a net rate of 8%, will fund the benefit payments for the Phantom Stock Plan, as well as provide a death benefit in the case of pre-retirement death.

advantages of life insurance plan fundingThe internal growth of life insurance is tax deferred providing a favorable impact on financial statements. There is tax-favored access to the policy’s cash value, where withdrawals to basis and loans are tax-free for funding benefits. The use of Sun Executive Variable Universal Life allows for mutual fund-like sub-accounts and tax-free transfers from one fund family to another. There is also income tax-free death benefits available to the employer to offset the cost of the Phantom Stock Plan.

tax treatment of the planThe key employee does not recognize income on the grant of the Phantom Stock since the plan is an accounting method, not an actual transfer of a benefit. The key employee is taxed at ordinary income rates on the payment of the benefits under the plan when they are received.

The business is entitled to a deduction at the same time and in the same amount as the participant’s ordinary income recognition.

conclusionA Phantom Stock Plan is a type of non-qualified deferred compensation arrangement. However, unlike most other types of non-qualified deferred compensation plans, a Phantom Stock Plan gives the employee a piece of the action. For the employer, it is desirable because it does not require a transfer of stock to the employee. The employee participates in the future growth of the business through appreciation in his or her Phantom Stock units.

Benefits of a phantom stock planemployer• No true equity transfer• Simplicity• Golden handcuffs • Provides incentive to key employees to

increase the value of the business • Selective• Tax deductible when paid out

employee• Select key employees benefit from the

profitability in the business• No immediate income taxation• No reduction in compensation or cash outlay

required• May provide a death benefit to employee’s family