Executive Bonus Plans
What is an executive bonus plan?
An executive bonus plan is a way for a business to reward a key employee with life insurance the employee owns. The business pays the premium as a bonus. The employee owns the policy, names the beneficiary, and keeps the policy if they leave the business.
It is sometimes called a Section 162 plan, after the section of the tax code that covers it.
What problem does it solve?
Every business has people it cannot afford to lose. A top producer, a manager who holds the operation together, a specialist clients ask for by name. Salary alone rarely keeps those people. They can get salary anywhere.
An executive bonus plan gives them something personal and lasting: life insurance that protects their family and builds cash value they control. It is a benefit that follows them, not a benefit that stays with the business.
How does it work?
- The business and the employee agree on the plan. The business pays the premium on a life insurance policy the employee owns.
- The premium is treated as bonus income to the employee, and it is generally deductible to the business as compensation. Your CPA confirms the treatment for your business.
- The employee names the beneficiary. If the employee dies, the death benefit goes to the family, income tax free in most cases.
- The policy can build cash value the employee can access during life, for needs such as education or retirement income, depending on the policy design.
- If the employee leaves, the policy goes with them. They can keep paying the premium themselves or adjust the policy.
Some businesses add a second bonus to cover the tax on the first bonus. That is called a double bonus arrangement, and it is simply a larger bonus designed so the employee is not out of pocket for the tax.
Who owns what?
- The employee owns the policy, controls it, and names the beneficiary.
- The business pays the premium and, in most cases, has no claim on the policy.
- The business can stop paying the bonus at any time, though the agreement should say so clearly in advance.
What should you watch out for?
- The bonus is taxable income to the employee, so the employee needs to understand the tax cost. A double bonus can cover it.
- The plan is selective. It is offered to a small number of key people, not to everyone, and that should be documented.
- The policy should fit the employee, not only the business. A review with the employee matters.
- The agreement should be in writing, reviewed by your attorney and your CPA.
Who does it fit best?
- Businesses with one or a few people who are hard to replace
- Owners who want to reward key people without the cost and complexity of a plan for everyone
- Businesses that want a benefit the employee keeps for life
Common questions
Is the premium deductible to the business?
Generally yes, as compensation, when the arrangement is structured correctly. Your CPA confirms this for your business.
Does the employee pay tax on the bonus?
Yes. The premium is bonus income to the employee. A double bonus arrangement can pay the extra tax as well.
What happens if the employee leaves?
The employee keeps the policy. That is one of the strengths of the design. The benefit is theirs.
How is this different from key person insurance?
An executive bonus plan is a benefit for the employee. The employee owns the policy and the family receives the death benefit. Key person insurance is protection for the business. The business owns the policy and receives the benefit. Many businesses use both.
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Content on this page is for education only and does not constitute financial, tax, or legal advice. Please consult your tax advisor or attorney regarding your specific situation.
