Retain and Reward Key Employees with an Executive Bonus Plan

One way business owners can try to retain and reward their key employees is by offering extra compensation in the form of a nonqualified executive bonus. These types of plans often use permanent life insurance as the funding vehicle.

What it is?
An executive bonus arrangement is an addition to regular salary or compensation that business owners can provide to key employees or executives of their choice. There are no legal requirements for anything to be filed with the government or for the plan to be in writing. However, a written plan is often desirable because it can outline conditions that must be met in order for the employee to qualify for the bonus, and state the obligations of the business to pay the bonus.

How does it work?
The business provides extra compensation to the key employee in the form of a bonus. If life insurance is used as the funding vehicle, the employer may make the bonus payment directly to the insurance company, or the employee can make the premium payments.

In some instances, the employer will pay a “double bonus” to the employee to pay for any income taxes owed by the employee that are attributable to the bonus. To cover premium payments and to maintain the tax advantages of cash accumulation for the employee, the employer should plan on making ongoing bonus payments instead of a one-time bonus so the policy isn’t classified as a modified endowment contract.

The employee is the insured and owner of the life insurance policy and may name the policy beneficiaries. The life insurance policy may accumulate cash value, which can be accessed by the employee during his or her lifetime. Generally, any cash accumulation within the policy will grow tax deferred. Policy death benefits are paid to the employee’s beneficiaries named in the policy.

What are the tax considerations?
Bonuses are generally deductible by an employer according to the same rules as other forms of cash compensation. A bonus cannot be deducted unless it constitutes a reasonable allowance for services actually rendered.

A bonus is taxed to the employee as ordinary taxable income. 

Considerations for the employer

  • The bonus can attract, motivate and retain key employees
  • The plan is generally simple to implement and easy to administer, with no formalities or funding requirements
  • The employer may be able to deduct the bonus as a reasonable business expense
  • The employer can set terms and conditions that must be met by the employees to qualify for the bonus

Considerations for the employee

  • The employee receives life insurance protection for his or her family at little or no cost
  • The employee owns the policy and names the beneficiaries
  • Permanent life insurance may accumulate tax-deferred cash value over time, which the employee can access to supplement retirement or to meet other needs or expenses
  • The bonus may be contingent on continued employment or performance goals
  • The employee must be insurable in order for life insurance to work as the plan funding vehicle
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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