Broker Check

Bonusing with an Executive Bonus Plan

July 19, 2022

Although often used by Mark Twain, the quote “nothing in life is certain except for death and taxes” originated in a letter written by Benjamin Franklin. The humor in the statement comes from its frank truthfulness: we all will die and before that fateful day everyone is affected by the tax code. Although neither is fun to talk about (probably why life insurance is not called death insurance) there is a way that businesses can use both “certainties” to put a smile on the face of a key employee.

The Power of a Fringe Benefit

Businesses are often looking for creative ways to lure or keep quality people by offering forms of compensation that go beyond monetary pay or predictable benefit packages that include health insurance, paid time off and a qualified retirement plan. An executive bonusplan is one such offering that can be selective and is easy to administer. The organization buys life insurance on behalf of the employee with the intention of paying future “bonuses” to cover premium costs. Term insurance, which comes with an expiration date and has no cash value, is sometimes used. However, executive bonus plans are normally structured using a permanent policy (universal or whole life). The bonuses are compensation and taxable to the employee as ordinary income while the business enjoys a normal tax deduction. Some companies provide additional compensation to cover the taxes so that the recipient is not required to reach into his/her pocket.  

The employee not only feels special in receiving a benefit not enjoyed by all employees, but receives compensation that has some real tax advantages. Life insurance payouts from either a term or permanent policy are tax free to the beneficiaries. Permanent insurance policies accumulate cash on a tax-deferred basis that the employee can access tax-free up to the cash basis, i.e., the amount contributed. The said person could also borrow the excess without paying a tax.

Employee Retention

Offering such a plan is a relatively inexpensive way to offer an employee a valuable perk and a written agreement should be established so that both sides understand the ground rules. Some companies will include a provision forbidding the employee from accessing the cash value until a future date such as retirement age or meeting a length-of-service requirement. This is done to incentivize employees to stay or to prevent them from using the money to start up a competing business.

Advantages Compared to Qualified Retirement Plans 

While qualified retirement plans have several major tax advantages, those federally approved programs come with filings and extra paperwork. Executive bonus plans have several features that make them attractive to even the smallest businesses:

  • Tax deductible as a business expense
  • Provides benefits for retirement, disability, and death
  • Accumulates funds on a tax-deferred basis
  • Allows organization to choose participants
  • No government filings and limited paperwork
  • Avoids the “reverse” discrimination of pension plans against highly compensated employees

Not the Same Old Same-Old

A company may have a bread-and-butter benefits package but what can it offer a special employee without breaking the bank? An executive bonus plan is a simple way to provide a selective, high value benefit. Speak with a financial advisor to get the full picture on how to set up such an arrangement.