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University of Massachusetts Amherst

Family Business Center

Golden Handcuffs Make It Unprofitable to Walk Away

by Shel Horowitz

The question arises over and over again: how can a family business owner reward —and maintain the loyalty of—a key employee without opening up discrimination suits or other problems.

Family Business Center sponsor Charlie Epstein, of Epstein Financial Services, has the answer: there are a number of perfectly legal ways to not only let your key employees benefit, but make it financially unprofitable for them to walk away from your company. Typically, these involve deferred compensation such as stock options, that the employee receives after a period of years, or perhaps after retirement.

These kinds of packages are known as “golden handcuffs,” because they lock your employees into staying with you, otherwise they forfeit significant income—during retirement, in most cases, but of course, they can be structured to meet the particular goals you have (such as meeting performance goals)

Federal law prohibits the employee from actually collecting any deferred compensation until retirement. If the obligation is there, the company should set up a funding mechanism, if it's privately held. And you want to create the smallest tax consequences possible for the money you're putting aside, which often means using insurance as the primary funding mechanism. “You can even design them so the corporation gets all their money back” at payout, Epstein says.

As an example, Epstein showed a spreadsheet that showed how an investment of $400,000 can convert to a payout of $1,500,000.

These types of funding arrangements may be beneficial for family members as well as a way of accumulating wealth outside of their qualfied 401k plans and as an alternative to generating retirement from the sale of the business. Children who are looking to purchase the business from their parents could even set up a deferred comp arrangement for mon or dad which could be used in the future to fund their retirement and not force the children to be “strapped” for cash or have to borrow from the bank to buyout their parents.

As with any arrangement of this kind you should always consult your legal and professional advisory team.

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