Section 162 Executive Bonus Plans

What is a 162 Executive Bonus Plan?

A 162 Executive Bonus plan allows a business to provide life and/or disability income
insurance to key executives using tax deductible dollars.

Insurance policies are owned by the executives and are paid for through cash bonuses to
the executives. In practice, the business may actually pay the premiums directly to the
insurance company, then include the amounts in the executives’ reported W-2 income.

The executive has all of the ownership rights of the policy, including the right to name
his or her own beneficiary(ies) and to access the policy cash values (except when a
Restricted Executive Bonus Arrangement is used, as explained below).

Benefits to the Business/Employer

  • The plan requires no administration costs, IRS approval, or complicated government
    reporting.
  • Provides a powerful means to attract, motivate, and retain quality employees.
  • May be provided on a selective basis, allowing the employer to choose specific
    employees to participate.
  • Benefit amounts may be varied among participants.

Benefits to the Executive

  • The executive is the owner of the policy with full rights to the policy and any policy
    cash values (possibly subject to a REBA, described below).
  • The bonus plan frees up personal funds that would otherwise be spent for personal
    life insurance needs.

Single vs. Double Bonus

In a “Single Bonus” design, the executive is responsible for paying the taxes on the
premium amounts paid (either directly or indirectly) by the employer.
In a “Double Bonus” design, the employer pays the premium amount, and provides a
cash sum to the executive to cover the tax on the premium amount. This makes the
entire bonus effectively tax-free to the executive.

Restricted Executive Bonus Arrangement

If cash value life insurance is used, a Restricted Executive Bonus Arrangement (REBA) may be incorporated into
the plan. The REBA prevents the executive from accessing the policies cash values without the consent of the
employer.

Employers often use this approach as a device to retain key employees. The employer usually develops a written
agreement with the executive that defines specific “qualifying” events that will trigger the release of the executive
from the agreement. For example, the REBA may be terminated in the event of the executive’s death, disability, or
retirement, or after a specified period of time such as 10 years. This technique creates a sort of golden handcuffs
providing incentive to the executive to remain with the business.

Taxation

  • Bonused amounts are tax deductible to the business if the bonuses are considered reasonable compensation.
  • Executives will owe income tax on the bonused amount when the bonus is received.
  • Death benefits are generally received by the executive’s beneficiary(ies) free of income tax.
  • Life insurance will be includible in the Executive’s estate if the employee retains incidents of ownership in
    the policy.

Considerations

  • Though it is not required, it is recommended that a written plan be developed—primarily because it helps to
    avoid disallowance of the employer’s deduction on the grounds that a bonus is unreasonable.
  • While there are no maximum or minimum contribution requirements, certain premium amounts may be
    necessary to help ensure the life insurance policy meets the desired objectives.

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