Executive Bonus Plans (162)

Selective, simple, and the business gets the deduction.

A Section 162 bonus plan is one of the cleanest ways to reward a specific key employee outside the qualified-plan world. The company pays the premium on a permanent life insurance policy the employee owns. The premium is treated as a bonus, the employee pays the tax on it, and the company deducts the bonus under IRC Section 162 like any other reasonable compensation.

No plan document. No discrimination testing. No top-hat filing. Just compensation.

Mechanism

The mechanics, step by step:

• The key employee applies for and owns a permanent life insurance policy (whole life, universal life, or indexed universal life are typical).
• The company pays the premium, either directly to the carrier or to the employee, and reports it as W-2 wages.
• The employee owes income tax on the bonus. The cash value grows inside the policy on a tax-deferred basis, and the employee can generally access cash value via policy loans or withdrawals in retirement.
• The death benefit passes to the employee’s named beneficiaries, generally income-tax-free.
• The company deducts the bonus as compensation under Section 162, provided total compensation to that employee remains reasonable.

A “double bonus” structure grosses up the bonus so the employee can pay the tax without out-of-pocket cost. The company deducts the larger bonus; the employee nets the premium.

Why it beats some alternatives

Compared to non-qualified deferred compensation:

• No plan document. A 162 plan is just an agreement to pay a bonus. NQDC requires a written plan complying with IRC 409A.
• No top-hat filing. Most NQDC plans require a one-time Department of Labor filing. 162 plans don’t.
• No rabbi trust. NQDC dollars sit on the company’s balance sheet, exposed to corporate creditors. The 162 policy belongs to the employee from day one.
• Selective. The company chooses who participates and at what level. No coverage tests.
• Portable. If the employee leaves, they leave with the policy. That’s a feature for the employee and, when designed properly, a recruiting advantage for the company.

Restricted vs. standard

A standard 162 bonus plan gives the employee full ownership of the policy immediately. That’s simple but provides no retention hold.

A Restricted Endorsement Bonus Arrangement (REBA) layers on a restriction: the employee owns the policy, but a separate agreement prevents the employee from accessing the cash value (and sometimes from changing the beneficiary) until they meet a vesting schedule or stay for a defined period. The death benefit and ultimate ownership stay with the employee; the policy’s accessible value becomes the golden handcuff.

For a high-impact employee the company really wants to keep, the REBA structure is often the sweet spot.

Common uses

• Supplemental retirement for a key employee already maxed out in the qualified plan.
• Family-business succession funding for a non-owner family member or non-family successor.
• Partner-level rewards in a partnership, where qualified plan limits can’t accommodate the desired contribution level.
• Recruiting incentive for a specific senior hire.

Pitfalls

• Reasonable compensation. The bonus has to fit inside total compensation that’s reasonable for the role. Over-stuffing a 162 plan to skirt that line invites IRS challenge to the deduction.
• No exit plan. What happens if the employee leaves before retirement? A standard 162 plan offers no recapture. A REBA structure with proper drafting does.
• Optimistic policy illustrations. Indexed UL and similar products are sometimes sold using illustrations that the policy may not deliver. Stress-test the design against more conservative crediting assumptions before signing.
• Skipping the agreement. A 162 plan should still have a short written agreement memorializing the arrangement, the bonus amount, and the conditions. “Handshake” 162 plans create confusion later.