Executive Bonus Strategies: A Simple Overview for Business Owners

Finding effective ways to reward and retain key employees is a common challenge for business owners. While salary increases and traditional benefits are important, they may not be enough to differentiate your business from competitors or to create a meaningful sense of long-term commitment.

An executive bonus strategy — sometimes called a Section 162 bonus plan — is one option that many business owners find worth exploring.

What Is an Executive Bonus Strategy?

An executive bonus strategy is an arrangement where the business provides a bonus to a selected key employee. This bonus is used to pay premiums on a life insurance policy that is owned by the employee.

The key elements include:

• The business pays a bonus to the selected employee
• The bonus funds a life insurance policy owned by the employee
• The policy may build cash value over time, depending on the product type
• The employee benefits from both the death benefit and potential cash value accumulation
• The business may be able to deduct the bonus as a compensation expense, depending on applicable tax rules

Why Do Business Owners Consider This?

Executive bonus strategies address several common business needs:

Retention: When a key employee knows that the business is investing in their long-term financial well-being, it may strengthen loyalty. Plans can include vesting provisions (through a restricted endorsement bonus arrangement, or REBA) that encourage employees to stay.

Simplicity: Unlike qualified retirement plans, executive bonus strategies generally do not require complex plan documents, ERISA compliance, or nondiscrimination testing.

Selectivity: The business owner may choose which employees participate. There is no requirement to offer the plan to all employees.

Flexibility: Plans can be structured in several ways depending on business goals — from simple bonus arrangements to more structured approaches with vesting schedules.

Common Plan Designs

Simple Bonus: The business provides a bonus equal to the policy premium. The employee reports it as income and pays the applicable tax.

Double Bonus: The business provides an additional bonus to help cover the employee's tax liability on the primary bonus. This may make the arrangement more attractive to the employee.

REBA (Restricted Endorsement Bonus Arrangement): Includes restrictions that limit the employee's access to cash value until certain conditions are met — such as a vesting period. This may help the business retain the employee for a longer period.

Tax Considerations

The tax treatment of executive bonus arrangements depends on the specific plan design and applicable tax law. Generally, the business may deduct the bonus as a compensation expense, and the employee reports it as income. The cash value growth inside the life insurance policy may be tax-deferred.

It is important to consult with a qualified tax advisor to understand the specific implications for your situation.

Is This Worth Reviewing for Your Business?

Consider exploring this option if you have key employees you want to retain, if you are looking for compensation strategies beyond traditional benefits, or if you want a relatively straightforward approach to providing long-term value to key people.

A complimentary 15-minute review with Scott Reinhart can help you understand whether an executive bonus strategy may be appropriate for your situation — with no cost and no obligation.