Executive Bonus: A Life Insurance Incentive

An executive bonus plan is a compensation strategy that provides additional benefits to key employees or executives. This plan is a type of life insurance where the employer pays the premiums as a bonus. It is also known as a Section 162 plan. The employee owns the life insurance policy, designates the beneficiary and may access other benefits such as the cash value and accelerated benefits. Executive bonus plans are typically offered to C-suite employees and can be structured in various ways, often tied to performance. They are a way for companies to attract, reward, and retain top talent.

How executive bonus plans work

Executive bonus plans are a compensation strategy that provides additional benefits to key employees or executives. They are typically offered to C-suite employees such as chief executives, chief operations executives, and chief financial officers.

Step 1: The employer takes out a life insurance policy

The first step is for the employer to take out a universal or permanent life insurance policy on a key employee, such as an executive. This policy serves as an incentive for the employee to perform at their best and contribute to the company's success.

Step 2: The employer pays the premiums through a bonus

The employer then provides the employee with a bonus that covers the cost of the life insurance policy premiums. This bonus is typically tax-deductible for the employer and considered additional taxable compensation for the employee. The bonus can be paid directly to the insurance company or given to the employee, who then pays the premiums themselves.

Step 3: The employee becomes the owner of the life insurance policy

The employee owns the life insurance policy and has the right to designate the beneficiaries. They may also access other benefits, such as the cash value and accelerated benefits. The employee can determine how the funds within the policy are managed.

Step 4: The employee can access the cash value of the policy

Upon retirement, the employee can access the cash value of the policy for extra income or to address personal needs. The cash value can also be accessed by the beneficiary or used to supplement retirement income or for any other financial need.

Step 5: The death benefit is paid to the employee's beneficiaries

In the event of the employee's death, the death benefit from the life insurance policy is paid to their family or other named beneficiaries, usually income tax-free.

Executive bonus plans can be structured in various ways and often include conditions, such as a service agreement or a vesting schedule, to provide incentives for employees to remain with the company. They are a valuable tool for attracting, rewarding, and retaining top talent in an organisation.

Types of bonus plans

Executive bonus plans can be customized and structured in different ways. The three main plan variations are single bonus designs, double bonus designs, and controlled executive bonus plans.

Single bonus arrangements mean the employer pays the employee a bonus to cover their life insurance premiums. However, the employee is responsible for paying the taxes on the premium amounts paid by the employer.

Double bonus arrangements mean the employer pays the employee a bonus to cover both their life insurance premiums and the income taxes on the premium amount. This setup means the employee doesn't have to pay any of the expenses of the policy.

Controlled executive bonus plans give the employer more control over the policy. The company and the employee have a predetermined vesting schedule for the policy's cash value accumulation. In other words, the employee must fulfil the vesting schedule to access the policy's cash value.

There are also three common types of executive bonus strategies: executive bonus arrangement, golden executive bonus arrangement (GEBA), and golden executive match (GEM). A GEBA may be sought by a company that wants to restrict how an employee uses the policy cash value and potentially recover costs if the employee leaves prematurely. A GEM may be sought by a company that needs a more cost-effective strategy to provide additional benefits to key employees.

Advantages of executive bonus plans

Executive bonus plans are a great way to attract and retain top talent. They are a win-win for both the employer and the employee. Here are some advantages of executive bonus plans:

Incentivising hard work

The keyword here is "bonus". Offering life insurance as a benefit is not just a standard perk of being employed by your company. It is a bonus that is earned based on performance. This means that you can decide which executives are worthy of such a plan, according to their body of work and contribution to the company's growth.

Tax advantages

Executive bonus plans can be structured in a tax-advantaged way. The business can pay for the premiums with money that is fully tax-deductible, while the plan itself is owned by the executive. The cash value of the policy can also be accessed on a tax-favoured basis.

Easy to implement and administer

Executive bonus plans are typically easy to set up and maintain. They are also flexible, with various structures available, including single bonus designs, double bonus designs, and controlled executive bonus plans.

Cost-effective

Executive bonus plans can be a more cost-effective way to reward top talent compared to other types of benefits. They provide additional compensation at a lower current cost to the employer since they only apply to top-level employees.

Peace of mind for employees

Executive bonus plans offer financial security and peace of mind to employees, knowing that their families are protected if anything unexpected happens. This can lead to increased employee satisfaction and retention.

Disadvantages of executive bonus plans

Executive bonus plans can be a great way to attract and retain key talent. However, there are some disadvantages to consider before implementing them.

Firstly, the company has little control over the policy. Even if a controlled executive bonus is used to restrict the employee's access to the policy's cash value, the bonus is not recoverable, even if the employee leaves before vesting. This means that if an employee decides to leave the company, the business cannot get back the money paid out in bonuses.

Secondly, executive bonus plans can be costly for the employer, who bears the full cost of the plan. The company is also unable to recover these costs from the policy's death benefit, as the key executive chooses the policy beneficiary.

Thirdly, any bonus received by the employee must be included in their taxable income. This means that the employee will pay income tax on the bonus, reducing the net benefit they receive.

Finally, without additional planning, the life insurance policy's death benefit will be included in the key executive's taxable estate. This could result in additional tax liabilities for the employee's beneficiaries.

Overall, while executive bonus plans can be a valuable tool for attracting and retaining key talent, there are some financial disadvantages for both the employer and the employee that should be carefully considered before implementing such a plan.

Executive bonus plan considerations

Executive bonus plans are a great way to attract, reward, and retain top talent. They are a win-win for both the employer and the employee. However, there are some considerations to keep in mind when implementing such a plan.

Firstly, it is important to note that the company has very little control over the policy. The employee owns the life insurance policy, designates the beneficiary, and can access other benefits such as the cash value and accelerated benefits. The company cannot recover its costs from the policy's death benefit, and the bonus is never recovered even if the employee leaves before vesting.

Secondly, the bonus is considered taxable income for the employee, which may impact their overall compensation and tax liability. To mitigate this, employers can opt for a double bonus arrangement, where they provide a bonus to cover both the life insurance premiums and the income taxes on the bonus amount.

Thirdly, the life insurance policy's death benefit may be included in the employee's taxable estate, which could result in additional taxes for their beneficiaries. Proper planning is necessary to avoid this issue.

Additionally, executive bonus plans should be structured carefully to ensure they are not subject to ERISA rules and to maximize tax benefits. The arrangement must not allow the employer to be a direct or indirect beneficiary of the policy, as this would impact the tax implications.

Finally, executive bonus plans are best suited for companies that want to reward a select group of key executives and avoid plan administration. These plans offer flexibility in choosing the key employees to reward and provide immediate tax deductions for the company.

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