IRS Section 162 Executive Bonus Plan

If your company is like most, its success depends upon the efforts of its best people. That is why it is essential to hire and retain talented, hard-working executives who can help your business prosper and grow. Competitive compensation and benefit programs are a fundamental component to attracting these professionals and retaining them for the future success of the business.

Many executives feel retirement savings programs are one of the most valuable benefits a company can provide. However, few small to mid-sized businesses offer retirement savings programs specifically for executives.

Executives are interested in supplementing their retirement savings because they are facing a looming retirement income problem on multiple fronts. Higher-earning employees may find limitations in the amount they are allowed to defer to a defined contribution plan, such as a 401(k). In addition, they face “compensation discrimination.” This refers to the fact that Social Security replaces a lower percentage of your pre-retirement income as you earn more.

Why aren’t business owners offering executives more ways to supplement their retirement plans? Many business owners think programs to do so are either too expensive or too difficult to administer.

There is an easy and effective way to provide executives with the benefits they want. It is called an Executive Bonus Plan. An Executive Bonus Plan is a fringe benefit, funded with life insurance, given to a select group of key employees and/or business owners. In addition to providing protection to the executive’s family during their working years, an Executive Bonus Plan funded with whole life insurance can provide tax-advantaged supplemental retirement income.

Executive Bonus Plans are relatively simple to set up and administer, and can accommodate almost any budget. They give small to mid-sized companies the ability to attract and retain valuable executives by helping provide the additional benefits they seek.

How the plan works

Under an Executive Bonus Plan, the business enters into an agreement with an executive to pay all or part of the premiums for a life insurance policy owned by the executive. The policy provides permanent life insurance protection for the executive and will build attractive cash value/account value over time.

The business selectively chooses which executives will receive this valuable benefit. The bonus amount is fully tax deductible to the business, assuming it represents reasonable compensation, and is taxed as ordinary income to the executive. Plans may be designed to reduce or eliminate the after-tax expense to the executive.

There are various plan designs such as 1) The Executive Double Bonus Plan, 2) The Restrictive Bonus Plan and 3) The Leveraged Executive Bonus Plan. The last plan design is probably the best if you are private company. Because of the provisions of the Sarbanes-Oxley Act of 2002 that prohibit loans to executives of public companies, Leveraged Bonus Plans are not appropriate for publicly traded corporations.

Benefits to the business

  • An Executive Bonus Plan can be an effective recruiting and retention tool that provides benefits over and above a standard compensation package.
  • The company may offer the benefit on a discretionary basis and can vary the insurance coverage and premium bonus by employee.
  • Increased cost-efficiency by only offering benefits to select employees.
  • There are minimal implementation and administrative expenses. A basic plan does not require IRS approval and there are no required ERISA filings.
  • The bonus payments provide an immediate income tax deduction, subject to applicable compensation limits.
  • The plans are flexible and have the potential to include optional incentives for executives to achieve specific tenure or performance requirements

Benefits to the executive

  • The executive owns the life insurance policy and designates the beneficiaries.
  • The life insurance death benefit will generally be paid income tax free to the executive’s beneficiaries.
  • The policy cash value accrues tax deferred and may be accessed during retirement on a tax-advantaged basis to supplement the executive’s retirement income.
  • Since the executive owns the policy, the benefits are not subject to claims of the business’ creditors.

For such a powerful and varied plan, the options are almost limitless for how you can go about securing the most important aspect of your business: the managers and employees that keep it competitive. Letting them know that their futures and the futures of their family and estate are taken care of is priceless, no matter how much money actually changes hands. Depending on your company specifics, the 162 bonus plan or the NQDC could work better for you. Contact the experts at BeamaLife today for more information on providing peace of mind to your top executives.