As your employees, key executives will:
- Own a life insurance policy
- Accumulate cash value for retirement
- Accumulate cash value on a tax-deferred basis
- Receive income-tax-free benefits during life (under current tax laws)
- Receive a cash death benefit for beneficiaries that can be used to settle their estate.
With an executive bonus plan, key employees own life insurance on their life and your business pays the premium directly or indirectly through a salary bonus.
The bonus amount is deductible by you under Section 162 of the Internal Revenue Code as an ordinary and necessary expense. The same bonus amount is taxable to the employee as ordinary income just like any other cash bonus. In addition, you always have the option to increase bonus payments to offset your employee’s income tax liability. Qualified retirement plans are federally approved plans that have several major tax benefits. Employer contributions can be deducted for income tax purposes, but when funds are distributed at retirement, they will be subject to income tax. In addition, qualified retirement plans have strict reporting requirements and rules guarding against discrimination. An executive bonus plan includes the best features of a qualified plan and eliminates its worst features.
When considering an executive bonus plan, take into account the following:
- An employer cannot be the beneficiary of the insurance policy.
- The premium amount is additional compensation for the executive.
- A written agreement between the employer and the executive should be established
- The executive must pay income tax on the amount of the premium paid by the employer
The employer could bonus the extra money needed to pay the tax, or the tax could be paid by policy loans or withdrawals.
Executive bonus plans allow for almost unlimited flexibility in design to help highly compensated executives deal with limitations created by governmental regulations and limitations of qualified plans.
Double Bonus
With this executive bonus plan design alternative, the employer bonuses all of the premium, plus an additional sum, to cover the income tax due by virtue of the executive bonus plan. Because the executive is reimbursed for the tax outlay, he or she doesn’t have to reach into his or her own pocket or use the life insurance policy as a tax payment source.
Executive Contribution
Another alternative of an executive bonus plan allows the executive to add to the premium. Once the employer determines a premium amount, the executive may contribute his or her own money to supplement the fringe benefit plan
Custodial Executive Bonus
The third variation of a standard executive bonus plan, a custodial executive bonus plan, adds the element of employer control. The employer and executive enter into an agreement that details the restrictions placed on the executive’s ability to exercise policy ownership rights. During the term of the plan, the executive needs the employer’s consent to access the policy’s cash value.
The custodial arrangement is used when an employer is concerned about the employee leaving and perhaps using the cash value buildup to start a competitive business venture. Typically, restrictions remain in place until the executive reaches a stated retirement age or satisfies a length-of-service requirement. Once the required conditions have been met, the executive is free to exercise all ownership rights without any employer restriction. At no time does the employer ever own the policy in a custodial executive bonus plan or have any reversionary rights.
As stated earlier, one of the primary advantages of an executive bonus plan is its simplicity. The tax consequences of an executive bonus plan are straightforward and easy to understand.
Income Tax
IRC Section 162 permits an employer to take deductions for ordinary and necessary business expenses. This includes deductions for reasonable salaries or other compensation for personal services.
Special attention should be given to an executive bonus plan when the executive also is a shareholder in a closely held corporation. In this situation, the bonus should be designated clearly as compensation for services performed by the executive and be reasonable in amount.
At retirement, the executive can take annual withdrawals or loans from the policy. The amount of income available at retirement will depend on the amount of premiums paid over the years, as well as the executive’s age and health at the time the policy is purchased.
How to Begin
To establish a plan, decide which of your executives are vital to your business and gather the following information:
- Name, gender and date of birth of the executive(s) to be covered.
- Amount of coverage desired or premium commitment
- Tax brackets of business and individual executive(s)
- Executive Bonus Plan Agreement
- Executive Bonus Minutes from Board of Directors
To see a sample information, please select the link below. Remember, the results will be different in every situation, please use the “Schedule Appointment” link below for a confidential interview without obligation or pressure to see if you can utilize this remarkable program.
40 year old male 500,000, maximum funding
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