A Section 162 executive bonus plan allows an employer to provide life and disability income insurance to key executives using tax-deductible dollars.
Insurance policies are owned by the executives and are paid for through cash bonuses to the executives. In practice, the employer may actually pay the premiums directly to the insurance company, then include the premium amounts in the executive’s reported W-2 income.
The executive has all of the ownership rights of the policy, including the right to name beneficiaries and to access the policy cash values, with certain exceptions.
In a single bonus design, the executive is responsible for paying the taxes on the premium amounts paid by the employer.
In a double bonus design, the employer pays the premium amount and provides a cash sum to the executive to cover the tax on the premium amount. This makes the entire bonus effectively tax-free to the executive.
If cash value life insurance is used, a restricted executive bonus arrangement (REBA) may be incorporated into the plan. The REBA prevents the executive from accessing the policy’s cash values without the consent of the employer.
Employers use this approach as a device to retain key employees. The employer usually develops a written agreement with the executive that defines specific qualifying events that will trigger the release of the executive from the agreement.
For example, the REBA may be terminated in the event of the executive’s death, disability, or retirement, or after a specified period of time, such as 10 years. This technique creates a sort of golden handcuffs, providing incentive to the executive to remain with the employer.
The insurance company typically provides a Controlled Executive Bonus Agreement form that spells out the circumstances under which policy cash values may be accessed. The insurance company is not a party to the REBA and will typically only follow instructions it has been given in allowing or prohibiting access to cash values.
For Educational Purposes Only. This material is intended for informational purposes only and should not be construed as legal or tax advice. It is not intended to replace the advice of a qualified attorney, tax advisor, or plan provider. © Copyright 2019 M Financial Group. All rights reserved. 2491364.1 Expires 04/2021 M Financial Group | 1125 NW Couch Street, Suite 900 | Portland, OR 97209 | 800.656.6960 |mfin.com Internal Revenue Code Section 162(a)(1). Internal Revenue Code Section 101(a).