Executive Bonus Plans

Ideally, every company agrees that their company’s most valuable asset is its people, particularly key executives that they depend on to keep the business running smoothly. These executives are the people who provide leadership, specialized knowledge and skills which contribute significantly to the growth of the company. But if those key executives decided to leave, would your business be able to survive?

Need to create the plan

When you are running a business, it is important to consider an additional financial reward for deserving employees and making them feel valued and appreciated. In order to attract the executives to stay in their business, many companies offer rewards, incentives or bonus on top of their salaries. For this, they plan a structure, to benefit both the employee and the company respectively which is known as executive bonus plan.   

The valid reasons for creating an executive bonus plan includes:

• To share company profits with employees.
• To reward hard-working employees for a job well done.
• To boost employee morale and retain key employees.
• To respond to competitors who offer employee bonus plans.

The plan should be structured so that employees are motivated to focus their energy and efforts on activities that will help achieve specific and measurable business goal such as increase sales, improve new customer acquisition or existing customer retention, increase profitability, or achieve key performance indicators (KPIs).

Executive bonus plans are often referred to as Section 162 Plans because this section of the Internal Revenue Code states that, “An employer may deduct all ordinary and necessary business expenses including a reasonable allowance for salaries or other compensation for personal services actually rendered”. This section provides the legal basis for the income tax deduction of bonuses and other compensation that is paid.

How does it works

The benefits under an executive bonus plan usually includes life insurance policy, death benefits as well as cash value accumulations, which can be used as a retirement income supplement. These plans are simple in design and easy to implement. The executive bonus plan works as follows,

• Bonus by company: The company provides the key executive with a bonus that is taxable as income to the recipient. The bonus is generally a deductible business expense for the company.
• Life Insurance Policy: The bonus is used to purchase a whole life or universal life insurance policy that builds cash value that grows tax deferred. Access to the cash surrender value is restricted by the company until a specific date.
• Tax deferred growth: The life insurance policy, if properly structured, may provide an attractive benefit to the executive in the form of cash value growth. Any cash value accumulation will grow tax deferred and may be accessed by the employee income tax-free through withdrawals and policy loans. The policy’s cash value can be used to supplement retirement income or for any other financial need.
• Death Benefits: In case, if the key executive dies, the heirs will receive the death benefit proceeds from the life insurance policy income tax free.

Because the employee owns the policy, he or she can access the cash before retirement, tax free, by borrowing or surrendering cash value from the insurance policy in the event that money is needed.

Easy to structure

One nice thing about an executive bonus plan is that it can be structured in a number of different ways, depending on what makes the most sense for your company and what your goals are with regard to the key employee. There are a few examples:

• Reward the key employee for their loyalty: You can set up a vesting arrangement, restricting their access to the cash value of the policy until predetermined dates, or until they reach retirement. So the plan becomes a form of “golden handcuffs,” designed to keep the employee working at your company for as long as possible.

• Tie the plan to performance: If the employee doesn’t achieve certain goals or benchmarks, you can decrease or withhold the bonus amount.

• Double bonus the employee: The bonus you pay the employee is considered taxable income, so if you’re feeling extra generous, you can bonus them enough to cover both the premium and any taxes they’ll owe.