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An Executive Bonus (Section 162) Plan is a direct perquisite to a Key Person. These plans utilize a cash build up life insurance policy to accumulate cash that may be released to a Key Person upon meeting the criteria in a performance agreement.  In most cases, the company pays the premium until the Key Person’s retirement or planned separation date and then recovers the premium paid from the cash value (or until the premium is “paid-up”).  The Key-Person keeps the balance of the cash value and the remaining death benefit.  The terms “Executive Bonus” and “Section 162” refer to the company’s ability to expense the premium cost as a bonus to the Key-Person if the proper conditions are met and allowed under IRC Section 162.

The concept may be easier to understand than to implement.  The Key Person is the owner of the policy and has total control.  If the Plan is to be used as a retention incentive, the company wants to restrict access of all of the policy assets until the Key Person has met his/her performance conditions.  Otherwise, the Key Person could withdraw all of the policy’s cash value and then separate from the company before the predetermined separation date.  At that time, there would be no cash left in the policy to pay back the company for the premiums paid creating a difficult situation.

There are several approaches to allow the Executive Bonus Plan to work as a retention tool.  But in all arrangements, the employer having a security interest in the plan assets seems to be a violation of IRC Section 264(a)(1).  It state, “No deduction shall be allowed for premiums on any life insurance policy if the taxpayer is directly or indirectly a beneficiary under the policy or contract.” 

  1. Restrictive Agreement - Restricts the Key Person from accessing the cash value until a predetermined date without the consent of the company (if the insurance carrier and State regulations allows such a restriction).

  2. Leveraged Executive Bonus Plan – The company uses the policy as collateral for a loan paying the Key Person’s tax liability on the policy.  The company may also include a provision to forgive the loan at some future time where the cash value will be higher than the premiums paid.  In this arrangement, the security interest is not on the insurance policy, the insurance policy is being used as a security for the loan.

The description above is a general overview of Executive Bonus Plans and is not intended to provide all of the details of a plan.  A good financial planner will help you with all of the unforeseen scenarios and implement the controls to mitigate any problems you may possible have with these types of plans.

For more information, please contact Bridgeport Benefit Advisors.

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The material on this page is intended as general descriptions of the concepts presented.  It is for educational purposes only and it not intended to provide specific financial or tax advice.  These descriptions cannot take into account your specific conditions and situation including the data required for underwriting purposes, financial circumstances, risk tolerance, and other factors.