Executive Bonus Plans & Retaining Key Executives

The retention of employees has been on the minds of many lately – including advisors and their business owner clients. Business owners are more concerned than ever in retaining and rewarding their key employees and executives in order to maintain their businesses and manage  them  efficiently.  At Appel Insurance Advisors, we’ve received numerous requests that suggest this “concern” is factoring into the financial planning for many businesses.

One longtime employee retention plan is called a Section 162 bonus plan. When was the last time you used one of these for a client? Appel Insurance Advisors has quoted these periodically, but recently received a similar request from two different advisors who were interested in using this to help their corporate clients. We presented a Double Bonus Funding Pattern with a Restrictive Endorsement.

A 162 Bonus Plan aka Executive Bonus Plan

 What is a Section 162 Bonus Plan or an Executive Bonus Plan? This is a plan put in place by an employer that is essentially a “raise in pay” that usually involves the purchase of a life insurance contract on the life of an employer’s selected key executive. The employer pays the premiums on the policy in the form of the bonus and can deduct that amount as a business deduction for ordinary and necessary business expenses under Section 162(a)(1) of the Internal Revenue Code of 2001. Total compensation, including bonus, must stay within the bounds of reasonable compensation.

How an Executive Bonus Plan Works

The following is a basic structure for an Executive Bonus Plan:

1.     The insurance policy is owned from the outset by the executive. The executive names their beneficiary and has all rights of ownership in the contract.

2.     The employer pays the bonus in the form of premiums sent directly to the insurer.

3.     The entire premium paid is by the employer under an executive bonus arrangement and is charged to the executive as ordinary compensation income and reported on their IRS Form W-2. Each bonus is subject to FICA and FUTA tax. The bonused premiums are considered a non-cash, fringe benefit for withholding purposes, so the premiums will be added to regular cash wages paid during the year and the appropriate withholding adjustment will be made. In many cases, the employer will assist the executive even further by paying an amount sufficient to pay both the premiums and the tax on the bonus. This is

often called either a “double bonus” or “grossing up.” (The arrangement is generally not recommended for S Corporation owners or partners since those businesses are not separate taxpaying entities.)

Restrictive Endorsement Bonus Agreement (REBA)

A Restrictive Endorsement is created between the employer and the key executive. This agreement requires the employer’s  consent  for  the  executive  to  have  access  to  the  policy  values,  which provides enticement for the executive to remain employed for a specific length of time. The agreement may also stipulate a vesting and repayment schedule in the event the executive does not fulfill the employment time frame set forth in the agreement. Appel Insurance Advisor's plan was designed to allow the executive 10% access to the cash value in year one and this will increase by 10% each year through year 10. In year 10 the Executive will be fully vested in the plan and will have 100% access to the cash value. Our carrier partner on this case has the administrative processes in place to help implement and monitor the terms of the Restrictive Endorsement.

Highlights of an Executive Bonus Plan

For the Employee:

·       The policy funding the plan is owned by the executive

·       The plan can be designed to meet personal needs

·       The executive’s tax cost can be covered by an additional bonus from the employer

·       Any growth in policy cash values accumulate tax deferred

·       Tax preferred income can be received from the plan via withdrawals and loans

·       The executive has some control over the plan, including beneficiary selection and asset allocation

For the Employer:

·       Bonuses are tax-deductible

·       The employer has complete discretion in selecting who is included

·       There are no maximum or minimum contribution requirements

·       No IRS approval required

·       Minimal administration expense

  ·         Plan may be terminated at any time pursuant to the agreement

·         Plan design is simple

Using a Restricted Endorsement Bonus Arrangement (REBA) can create “golden handcuffs”

Underwriting for This Solution

The executive will need to be fully underwritten for use of this solution. If the key executives are younger, they can apply through Accelerated Underwriting (AUW) which could result in a quick turn-around assuming they qualify.

More business owners and employers are looking to retain key executives during this challenging job market. An Executive Bonus Plan arrangement is a creative way to help incentivize these executives. The additional compensation paid into the policy, the opportunity to eventually receive vested policy cash values, and the beneficiary death benefit may encourage key executives to remain employed longer.

Appel Insurance Advisors has the experience and knowledge to assist in the planning, underwriting, and placing of insurance solutions to fit any of your clients personal or business needs.

For more information please contact Appel Insurance Advisors at (617) 332-7900 or david@appeladvisors.com for more information.