Executive Bonus Plans
An Executive Bonus Plan, also referred to as Section 162 Plan, is a non-qualified plan used by employers to provide special compensation to key executives. The employers’ contribution to an executive bonus plan is considered salary to the executive and is therefore subject to taxation. Many employers provide for the taxes, aptly titled a Double-Bonus Executive Bonus Plan.
The employer pays the premiums on a permanent life insurance policy owned by an employee. Although a life insurance policy is not the only financial vehicle that can fund an executive bonus plan it is the most commonly used strategy. Permanent life insurance offers several benefits that make it especially attractive. In addition to providing death benefits, the cash value of a policy may provide additional income at retirement to the insured. Any type of permanent life insurance policy can be utilized in the plan. However, a universal life insurance policy offers the most flexibility which has made it a preferred choice for some employers. Since bonuses are typically performance based a universal life policy can handle the premium flexibility of exceptional performance (large bonus) and poor performance (no bonus) year to year.
Advantages to Employer:
- Ability to select one or a class or employees to participate in the plan while excluding others.
- Unlike other non-qualified plans, the employers’ premium payments are tax-deductible as compensation.
- Plans are easy to administer as premiums are paid as salary payments for accounting purposes. In addition, there are typically no government reporting or disclosure requirements in which the plan must comply with.
Advantages to the Executive:
- The plan provides the executive with post retirement benefits. The life insurance policy stays in force and access to cash value after the executive as retired or left the company.
- The plan is portable for the executive. Although the company will cease to make payments at separation of employment, the executive may elect to continue plan.
- The executives uses company funds to pay for personal life insurance that will benefits his/her family in the case of unplanned loss of life.
Disadvantages to Employer:
- Since the executive owns the plan the employer has no control over the policy or its values.
- Inability to recover any cost associate with the plan when the employee leaves.
Disadvantage to Employee:
- The amount bonused into the plan is considered income. However, many plans will also pay the taxes deeming the plan as a double-bonus executive bonus plan, thus eliminating this disadvantage.