Executive Bonus Plan Funded By Life Insurance: A Win-Win Strategy

 

As a business owner, you know how important it is to have a team of loyal, motivated, and talented employees who can help you achieve your goals. But how do you keep them happy and engaged, especially when they have other options in the market? How do you show them that you appreciate their contributions and value their skills?

One way to do that is to offer them an executive bonus plan funded by life insurance. This is a type of compensation plan that allows you to reward your key employees with a life insurance policy that they own and control, while also enjoying some tax benefits for your business.

In this article, we will explain what an executive bonus plan is, how it works, and what are the benefits for both the employer and the employee. We will also discuss some of the considerations and challenges that you may face when implementing this strategy, and provide some tips on how to make it work for your situation.

How an Executive Bonus Plan Works

An executive bonus plan is an agreement between a business and a select employee or owner, in which the business pays for a life insurance policy owned by the employee or owner. The bonus is taxable as income to the recipient, but may be deductible as an expense to the business. The purpose of an executive bonus plan is to motivate, reward, and retain key talent.

Here are the steps involved in setting up and implementing an executive bonus plan:

• The employer selects the key employee or owner who will receive the bonus plan. This can be anyone who is vital to the success of the business, such as a manager, a salesperson, or a partner.
• The employer chooses a permanent life insurance policy (either whole life or universal) that accrues value over time and provides a death benefit to the beneficiary. The policy can be tailored to suit the needs and preferences of the employee or owner.
• The employee or owner is the owner of the policy and gets to determine the beneficiaries and manage the funds within the policy. The employer has no rights or obligations regarding the policy.
• The employer covers the cost of the policy by periodically giving the employee or owner a bonus big enough to pay the policy premiums. The employee or owner then pays the premiums to the insurance carrier.
• The bonus is considered taxable income to the employee or owner, so they will have to pay income taxes on it. However, the employer may also give them an additional bonus to cover their tax liability. This is called a “double bonus” plan.
• When the employee or owner reaches retirement age — or sooner, depending on how the arrangement is set up — they can access the cash value of the policy for extra income if they want. They can also borrow against it or withdraw from it without affecting their death benefit.
• If the employee or owner dies, the death benefit of the policy would go to their family or other named beneficiaries tax-free.

An executive bonus plan can be structured in different ways depending on what makes sense for your business and your goals. For example, you can:

• Reward the key employee or owner 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 them working at your company for as long as possible.
• Tie the plan to performance: If they don’t achieve certain goals or benchmarks, you can decrease or withhold the bonus amount.
• Offer different levels of benefits: You can vary the amount of bonus, type of policy, vesting schedule, and other features depending on the rank or role of the key employee or owner.

Benefits for the Employer

Offering an executive bonus plan funded by life insurance can have several advantages for your business. Some of them are:

• Tax-deductibility: Because you’re bonusing the employee or owner to cover the insurance policy premiums instead of paying the insurance carrier directly, the bonus amount is generally considered “reasonable compensation.” So it’s tax-deductible, just like a straight-up cash bonus would be, but what you’re providing has greater long-term value to the recipient.
• Flexibility: You have the freedom to choose who will receive the plan, how much the bonus will be, what kind of policy to use, and how to structure the arrangement. You can also change or terminate the plan at any time, as long as you comply with the terms of the agreement.
• Simplicity: Setting up and administering an executive bonus plan is relatively easy and inexpensive compared to other types of compensation plans. You don’t need to create a trust, file any reports, or comply with any complex rules or regulations. You just need to have a written agreement with the employee or owner and pay the bonus as agreed.
• Attractiveness: An executive bonus plan can help you attract, retain, and motivate the best talent for your business. It shows them that you appreciate their work and that you care about their future and their family. It also gives them a sense of ownership and control over their financial security.

Benefits for the Employee

Receiving an executive bonus plan funded by life insurance can have several advantages for your key employee or owner. Some of them are:

• Tax-free death benefit: The most obvious benefit is that they will have a life insurance policy that will provide a tax-free income to their loved ones in case of their death. This can give them peace of mind and protect their family from financial hardship.
• Cash value accumulation: The policy will also build up cash value over time, which they can access for any purpose they want. They can use it for retirement, education, medical expenses, or anything else. They can also borrow against it or withdraw from it without affecting their death benefit, as long as they pay it back with interest.
• Tax-advantaged income: The cash value of the policy can provide a source of tax-advantaged income for the employee or owner. They can potentially receive income tax-free withdrawals and loans from the policy, as long as they don’t exceed their basis (total premiums paid) in the policy. If the policy is a modified endowment contract (MEC), however, all distributions (withdrawals or loans) are taxed as ordinary income to the extent of gain in the policy and may also be subject to an additional 10 percent premature distribution penalty prior to age 59½, unless certain exceptions are applicable.
• Ownership and control: The employee or owner is the owner of the policy and has full control over it. They can choose the beneficiaries, change them at any time, and manage the funds within the policy. They can also surrender or cancel the policy if they want, although they may have to pay taxes and penalties on the cash value.

Considerations and Challenges

An executive bonus plan funded by life insurance is not without its drawbacks or risks. Some of the potential issues that you may face when implementing this strategy are:

• Taxation: The bonus that you pay to the employee or owner is taxable as income to them, so they will have to pay taxes on it. This may reduce the net benefit that they receive from the plan. You can mitigate this by giving them a double bonus to cover their tax liability, but this will increase your cost and reduce your tax deduction.
• Vesting: If you want to restrict the access of the employee or owner to the cash value of the policy until certain conditions are met, such as reaching a certain age or staying with your company for a certain period of time, you will have to set up a vesting schedule. This may complicate the administration of the plan and require additional documentation and legal advice.
• Performance: If you want to tie the bonus amount to the performance of the employee or owner, such as meeting certain sales targets or profitability goals, you will have to establish clear and measurable criteria and monitor them regularly. This may create some tension or conflict between you and them if they fail to meet your expectations or if they disagree with your evaluation.
• Morale: If you offer an executive bonus plan only to a select group of employees or owners, you may create some resentment or jealousy among those who are not included in the plan. This may affect their morale and productivity and harm your company culture. You can avoid this by communicating clearly and transparently about the criteria and rationale for selecting the recipients and by offering other forms of recognition and reward to those who are not eligible.

Conclusion

An executive bonus plan funded by life insurance is a powerful tool that can help you reward your key employees or owners with tax-advantaged benefits while also enjoying some tax benefits for your business. It can help you attract, retain, and motivate top talent for your company and show them that you appreciate their work and value their skills.

However, an executive bonus plan also has some drawbacks and challenges that you need to consider before implementing it. You need to weigh the pros and cons carefully and consult with a financial professional who can help you design and manage an effective plan that suits your situation.

If you are interested in learning more about how an executive bonus plan funded by life insurance can work for you and your business, contact us today. We can help you find the best policy for your needs and guide you through the process of setting up and administering the