An Executive Bonus Plan is a type of life insurance policy provided to key executives as part of their overall compensation package. The employer pays the policy premiums, and the executive receives the benefits. This arrangement not only offers tax incentives but also motivates and retains high-value employees by enhancing their compensation package.
Definition
An Executive Bonus Plan is a strategic tool used by businesses to offer life insurance policies to their top executives. The employer pays the premiums, which are considered a deductible business expense, while the executive enjoys the benefits of the policy, including cash value growth and death benefits. This plan is often structured under Section 162 of the IRS Code, allowing the premium payments to be considered a bonus to the executive, who is then responsible for the income tax on the premiums.
Key Features
Types of Executive Bonus Plans
- Single Bonus Arrangement: The employer pays the life insurance premium, which is reported as taxable income to the executive.
- Double Bonus Arrangement: The employer pays an additional amount to cover the executive’s income tax liability on the bonus, essentially making the bonus tax-neutral for the executive.
- Restrictive Endorsement Bonus Arrangement (REBA): This plan adds restrictions to the policy, such as limiting the executive’s ability to access the policy’s cash value until certain conditions, like tenure or performance milestones, are met.
Special Considerations
- Tax Implications:
- For the Employer: Premiums paid are tax-deductible.
- For the Executive: Premium payments are considered taxable income.
- Ownership and Control: The executive owns the policy and can name the beneficiary, providing personal control and security.
Examples
- Single Bonus Plan: Company A pays $10,000 per year for a life insurance policy for its CEO. The CEO pays income taxes on the $10,000 as it is considered a bonus.
- Double Bonus Plan: Company B pays $10,000 per year for a life insurance policy for its CFO and an additional $3,500 to cover the taxes owed by the executive. The CFO thus receives the full benefit without a tax burden.
Historical Context
The use of life insurance as an executive benefit dates back decades, becoming popular in the latter half of the 20th century as a means to attract and retain top talent. Legislation such as the Internal Revenue Code Section 162 facilitated these plans by establishing clear tax guidelines.
Applicability
Executive Bonus Plans are utilized primarily in larger corporations looking to attract and retain top-tier executives. Small to mid-sized companies also use these plans to offer competitive compensation packages to key employees.
Comparisons
- Deferred Compensation Plans: Unlike Executive Bonus Plans, deferred compensation plans postpone the receipt of income until a future date, often retirement.
- Stock Options: Executive Bonus Plans provide immediate life insurance benefits, while stock options offer future financial benefits based on company performance.
Related Terms
- Key Person Insurance: Life insurance on a key employee, where the employer is the policyowner and beneficiary.
- Split-Dollar Life Insurance: A policy where life insurance benefits are split between the employer and employee.
FAQs
How does an Executive Bonus Plan benefit the employer?
Can the executive access the policy’s cash value?
Is the death benefit from the policy taxable?
References
- Internal Revenue Service. “Employer’s Tax Guide,” IRS Publication 15.
- National Association of Insurance Commissioners. “Life Insurance and Annuities (A) Committee.”
Summary
An Executive Bonus Plan serves as a formidable tool in a business’s arsenal for attracting and retaining talent. By offering life insurance policies as part of compensation, companies not only provide financial security to their executives but also align their compensation strategies with long-term business objectives. The tax benefits, control over the policy, and various structuring options make Executive Bonus Plans a versatile and valuable component of executive compensation packages.
