What is a 162 Executive Bonus Plan?
An executive bonus plan (Section 162) is a way for business owners or companies to provide additional supplemental benefits to key employees or executives of their choice. The benefits usually include life insurance policy death benefits as well as cash value accumulations that can be used as a retirement income supplement. With an executive bonus plan, the business can use tax deductible company funds to selectively provide valued benefits to key people. An executive benefit plan, used effectively, can be a valuable tool to attract and retain key executives.
Executive bonus plans are simple in design and easy to implement. The executive bonus plan works as follows:
The company provides the key executive with a bonus that is taxable as income to the recipient. The bonus is generally a deductible business expense for the company.
The bonus is used to purchase a whole life or universal life insurance policy that builds cash value that grows tax deferred. Access to the cash surrender value is restricted by the company until a specific date.
The life insurance policy, if properly structured, may provide an attractive benefit to the executive in the form of cash value growth. Any cash value accumulation will grow tax deferred and may be accessed by the employee income tax-free through withdrawals and policy loans. The policy’s cash value can be used to supplement retirement income or for any other financial need.
If the key executive dies, in most cases, the heirs will receive the death benefit proceeds from the life insurance policy income tax free.
Variations of Executive Bonus Plans
In addition to the basic executive bonus plan, there are other common plan variations. These options include a double bonus arrangement and a restricted or controlled executive bonus plan.
With a double bonus arrangement, the company will provide the key executive with a bonus large enough to pay the life insurance premiums as well as the income taxes incurred by the key executive on the bonus. The company can use the double bonus arrangement to eliminate any out of pocket expense for the key executive.
If the company wishes to retain some measure of control over the bonus, the controlled executive bonus design is a good choice. With a controlled executive bonus, the company and the key executive enter into an agreement which includes a vesting schedule on the policy’s cash value growth.