Director Fee Continuation Plan (DFCP)

What is a Director Fee Continuation Plan?

A supplemental director fee continuation plan is a deferred compensation agreement between the company and the directors whereby the company agrees to provide supplemental retirement income to the director and his family if certain pre-agreed upon eligibility and vesting conditions are met by the director. The plan is funded by the company out of cash flows, investment funds or cash value life insurance.  Any deferred benefits are not currently taxable to the director.  When paid, the benefits become taxable to the director as income and tax deductible to the company. An example of a typical plan would provide the director an annual payment of 50% of highest three year average fees payable for ten years. Payments commence at mandatory retirement age.

How do Director Fee Continuation Plans Work?

The company will book an annual expense equal to the present value of the stream of future benefit payments. Because of its many advantages, most companies use cash value life insurance to finance the DFCP agreement.  The company purchases a life insurance policy on the director’s life that is sufficient to recover the cost associated with the future benefits outlined in the agreement.  The company pays the premiums, owns the policy and is the policy beneficiary.  The policy cash values grow tax deferred and can be used at any time by the company at its discretion.

At retirement, the director receives supplemental income, paid by the company, based upon the terms of the agreement.  In the event of the director’s death, the policy’s death benefit is payable to the company to recover the cost of the plan and which can also be used to provide continued supplemental benefits or to provide a lump sum benefit to the executive’s named beneficiary.

Company Advantages with DFCP

Director Fee Continuation plans using life insurance have several advantages to the company:

  • DFCPs are relatively easy to implement and require no IRS approval or involved administration.
  • The company can select the director it wants to reward with supplemental benefits.
  • The company controls the plan, owns the policy and has book income from the policy cash value growth.
  • Cash value within the life insurance policy accumulates tax deferred.
  • When the supplemental income benefits are paid to the director, the company gets a tax deduction.
  • The life insurance policy can be structured to allow the company to recover its cost.

Director Advantages with DFCPs

Director Fee Continuation plans using life insurance also have several advantages to the key executive:

  • The plan can be custom designed to meet the director’s specific needs.
  • Supplemental retirement income can be accumulated without incurring any up front taxes.
  • In the event the director dies, the life insurance policy death benefits are available to fund the plan and provide a lump sum benefit to the director’s beneficiary subject to the terms of the agreement.

Disadvantages of DFCPs

  • The company does not get an immediate tax deduction on the premium payments. The deductions come for the business when plan benefits are paid to participant.
  • The cash value build up that accumulates inside the life insurance policy used to fund the DFCP is subject to the creditors of the company and is not protected if the company becomes insolvent.