Executive Bonus 162 Plans
Jason Stolz CLTC, CRPC
Executive Bonus 162 Plans offer a popular way to reward key employees through life insurance. Under Section 162 of the tax code, an employer pays a bonus to the executive, who then uses it to buy a life insurance policy—often whole or universal life. The key: the executive owns the policy, controls it, and receives the benefits, while the employer treats the bonus as deductible compensation. At Diversified Insurance Brokers, we help clients design ethical, efficient 162 bonus plans that support retention goals, tax strategy, and flexibility.
How a 162 Executive Bonus Plan Works
The employer pays a bonus directly to the employee (often in cash), and the employee uses that bonus to pay life insurance premiums. The company treats the bonus as deductible (up to compensation tax rules), and the employee owns the policy and can access the cash value or use the death benefit as they see fit. If structured correctly, the bonus is “grossed up” to cover tax withholding so the employee ends up net-neutral. Because the employee owns the policy, there’s no vesting or forfeiture risk inherent to many nonqualified plans.
Why Use an Executive Bonus Plan?
Executive bonus plans align incentives without creating nonqualified liabilities for the company. The employee owns the policy—they have control over cash value, loans, or withdrawals. The employer benefits from a retention tool, tax deduction for the bonus, and relatively simple administration. It’s often combined with other executive benefits like restricted stock or nonqualified deferred compensation to build a total rewards package. You’ll see it paired with key person life insurance for executives or used in hybrid retention strategies.
Design Choices and Considerations
Policy Type: Most 162 plans use permanent life—whole life or indexed/universal life—because the goal is long-term accumulation. You may also incorporate optional riders (accelerated death, term riders, etc.).
Bonus Gross-Up: To make the plan net-neutral for the executive, the employer may “gross-up” the bonus so the employee has enough to pay taxes on the additional income.
Duration & Vesting: While the employee owns the policy outright, some employers enforce voluntary retention periods by linking additional benefits or requiring repayment clauses for subsequent contributions.
Coordination with Other Benefits: 162 plans often coexist with nonqualified deferred compensation or split-dollar arrangements. The design must avoid conflicts in ownership, collateral, and cost allocation. We audit existing life plans (see review my life insurance policy) to ensure harmony.
Sample Scenario: Retention Built with a 162 Bonus
A company wants to reward Jane for long-term commitment. They enter a 162 bonus agreement: for each of 5 years, the company pays her a grossed-up bonus of $50,000, which she pays into a universal life policy. The policy builds cash value; Jane can borrow or access it later. If she leaves prematurely, the company may arrange a repurchase or require a repayment clause for unvested increments. The company deducts each year’s actual bonus paid as compensation expense.
Tax & Legal Aspects
The employer’s bonus is fully deductible under Section 162, just like salary or bonus. The executive pays ordinary income tax on the bonus they receive, which funds the life insurance premium. The death benefit is tax-free to the beneficiary, and cash value growth is tax-deferred. It’s essential to document properly—bonus agreements, premium receipts, and corporate resolutions—to satisfy IRS scrutiny.
Design a Bonus Strategy That Retains Executives
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Pros & Cons of 162 Executive Bonus Plans
Pros: Easy to understand and administer, full tax deduction for the employer, employee ownership and control, retention incentives without long-term liabilities.
Cons: Taxable bonus to the employee (requiring gross-up), limited to policies that justify the premium, potential issues if employee wants to terminate early or transfer the policy.
Comparing 162 Plans with Other Executive Benefits
Unlike split-dollar or restricted stock, 162 bonus plans don’t require vesting of the policy itself. They’re more flexible than nonqualified deferred compensation because the employee owns the policy directly. But they don’t always offer the same control as split-dollar designs—especially in shared ownership structures.
Why Work with Diversified Insurance Brokers
We bring deep experience designing nonqualified benefits. From bonus modeling to tax documentation, we align your executive strategy with your broader financial goals. We’ll also review your existing benefit offerings and show how a 162 plan fits into your retention and reward toolkit.
Related Topics to Explore
- Split Dollar Insurance Overview
- Non-Qualified Annuity
- Business Loan Life Insurance
- Contract Indemnity Life Insurance
FAQs: Executive Bonus 162 Plans
What is a 162 executive bonus plan?
It’s an arrangement where an employer gives a bonus to an employee, who uses it to pay premiums on a life insurance policy. The employee owns the policy and gets benefits; the employer gets a tax deduction.
Who owns the policy?
The employee owns it. Unlike split-dollar, the employer doesn’t share control, though repayment or recapture clauses can be included if the employee leaves early.
Is the bonus taxable to the employee?
Yes—it’s ordinary income. Many plans gross-up the bonus so the employee’s net after tax is used for premium payments.
Can the employee access the cash value?
Absolutely. Since they own the policy, they may borrow against or withdraw from the cash value, subject to policy rules.
What happens if the employee leaves?
Many plans include repayment or forfeiture clauses for unrecouped bonuses during a retention period. Clear exit language is essential.
Are there policy type restrictions?
Permanent life is preferred—whole, universal, or indexed policies. Term is rarely used because of its lack of cash value.
Can the employer be beneficiary?
Yes. The employer may be named as primary or secondary beneficiary, especially in key-person contexts. But if the employee inherits control, the designation should align with design goals.
Is this plan right for all executives?
It works when the executive values ownership and flexibility. If the goal is firm control or shared returns, split-dollar may be more appropriate.
What exit strategies exist?
Repay the bonus from cash value, swap the policy for compensation, or allow the policy to remain with the employee post-relationship.
What are the next steps?
We’ll model bonus amounts, tax gross-ups, policy illustrations, and retention agreements aligned with your objectives.
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