Executive Bonus Plans
As a successful business owner, you recognize that your key employees play a vital role in your day-to-day operations and ongoing success. You also know that while hiring the top talent you need is critical, so is keeping those talented employees loyal to your company. You may recognize the need to reward these individuals for their contributions, but realize it often takes more than salary alone.
A basic Executive Bonus Plan is very simple. The employee purchases a life insurance policy on his/her life, and the employer pays the premium (i.e., the “bonus”). The employer is eligible to take an income tax deduction on the bonus, only if reasonable,1 and the employee pays the taxes on the bonus. In some cases, the employer even pays the taxes for the employee through what is called a “double bonus.” The employee has full access to the policy cash value2 and the valuable tax-free death benefit3 will be paid to the employee’s beneficiaries upon the employee’s death.
The plan helps to ensure that your top performers will stay with your firm for the long term.
The plan is easy for your company to set up, and requires minimum administration. Documentation for the plan is straightforward. Neither ERISA reporting nor IRS qualification is required.
Your business is eligible for an immediate tax deduction for the bonus that you give to your executive.
You may choose which executives will be given bonuses — and the amount of each bonus.
There is an income-tax free death benefit for your employee’s beneficiaries.
The employee retains ownership of policy cash values that grow tax deferred and can be used for any purpose, including supplementing income in retirement.4
The employee’s only out-of-pocket cost for the plan is the tax on the bonus. Some employers use a double bonus and there is no cost to the employee.
There are no Internal Revenue Code contribution limits, and there’s no penalty for early surrenders or loans — provided the policy isn’t classified as a Modified Endowment Contract.
Executive Bonus Plans can be customized to meet the needs of your business. Following are some creative variations.
The employer pays the base premium on a whole life insurance policy and the employee may contribute additional funds as paid-up additions,5 which fuels the growth of the cash value and death benefit.
With this arrangement, the employer retains some rights in the policy for a specified period of time. An agreement is drawn up between the employer and the employee, detailing the obligations of each party. At the same time, a rider is added to the policy that restricts the employee’s access to the policy’s cash value until the employee has completed a specified number of years of service with the employer, as specified in the contract.6 The employee must fulfill all obligations under the contract before he or she can assume full ownership of the policy.
The employer pays a one-time bonus to the executive, who uses Guardian’s Payment of Premium in Advance feature to make a one-time payment that will cover all the policy premiums (without creating a Modified Endowment Contract).7
1 IRC Section 162 requires compensation to be “reasonable” in order for it to be tax deductible to the business.2 Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under age 59½, any taxable withdrawal may also be subject to a 10% federal tax penalty.3 Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, and accounting professional regarding your individual situation.4 Cash values in a whole life policy grow from dividends. Dividends are not guaranteed and are declared annually by Guardian’s Board of Directors.5 Paid-up Additions (PUA) are purchases of additional insurance (death benefit) that have a cash value. These purchases are made with dividends and/or a rider that allows the policyholder to pay an additional premium over and above the base premium. This creates the growth of death benefit and cash values in a participating whole life policy. Adding large amounts of Paid-up Additions may create a Modified Endowment Contract (MEC). A MEC is a type of life insurance contract that is subject to last-in-first-out (LIFO) ordinary income tax treatment, similar to distributions from an annuity. The distribution may also be subject to a 10% federal tax penalty on the gain portion of the policy if the owner is under age 59½. The death benefit is generally income tax free.6 Care must be taken to avoid “vesting schedules,” and any requirement to pay an amount that is specifically defined with reference to the premium payments. Such provisions may jeopardize the employer’s income tax deduction under IRC §162.7 IRC Section 162 requires compensation to be “reasonable” in order for it to be tax deductible to the business. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under age 59½, any taxable withdrawal is also subject to a 10% tax penalty. Prepayment interest rates are based on current factors. Prepaid premiums cannot be withdrawn except upon surrender of the contract and are subject to a surrender penalty. Management approval is required on premiums paid in advance for more than 20 years or amounts that exceed $100,000.