In today’s competitive business environment, attracting and retaining top executives is a challenge. High performing executives expect competitive compensation packages that go beyond traditional salaries and 401(k) plans. One of the most powerful yet underutilized strategies for rewarding key employees is the Executive Bonus Plan under IRS Section 162. While structuring an executive bonus plan as a life insurance policy offers tremendous benefits to the executive, it also offers significant tax advantages and long-term benefits to the company.

What Is an Executive Bonus Plan Under IRS Code Section 162?

An Executive Bonus Plan (or Section 162 Plan) is a compensation strategy where a business provides a cash value life insurance policy to a key executive. The company pays the premiums as a bonus to the employee, and the executive owns the policy. Depending on how the plan is structured, this can offer tax-efficient wealth accumulation, retirement income, and death benefit protection.

The company must treat premium payments as compensation and report them as income to the executive, it receives a tax deduction for the payments. The executive, in turn, can use the life insurance policy to generate tax-free income in retirement, access loans, or provide financial security for their family.

Structuring an Executive Bonus Plan: Three Key Approaches

There are several ways to structure an Executive Bonus Plan, each with unique benefits and strategic applications:

1. Executive-Owned (Standard 162 Bonus Plan)

In this structure, the executive owns the life insurance policy outright. The company pays the policy premiums, which are treated as taxable income to the executive. This approach provides the executive with full control over the policy, including the ability to access cash value, take policy loans, or designate beneficiaries. Learn more about how the policy works.

• Company Benefits:
  • Immediate tax deduction for premium payments.
  • No long-term liability or financial obligation beyond the bonus payments.
  • Simple and easy to implement.
• Executive Benefits:
  • Policy builds cash value, which can be accessed tax-free via loans.
  • Retirement income strategy that avoids direct taxation.
  • Death benefit protection for their family.

2. Split Dollar Plan

A Split Dollar Plan is a more controlled approach where the company and the executive share the cost and benefits of the life insurance policy. Typically, the company pays most or all of the premiums and retains a collateral interest in the policy equal to its contributions.

• Company Benefits:
  • Can recover its costs if the policy is structured properly.
  • Provides strong retention incentives, as executives must remain with the company to maximize benefits.
• Executive Benefits:
  • Still builds cash value for tax-free income.
  • May have reduced taxable income if structured properly.
  • Receives full death benefit coverage for their beneficiaries.

3. Company-Owned (Golden Handcuffs & Vesting Schedule)

In this structure, the company owns the policy and may implement a vesting schedule to incentivize long-term retention. The executive receives rights to the policy over time, but they must meet specific service requirements to gain full ownership.

• Company Benefits:
  • Provides a powerful retention tool (“golden handcuffs”).
  • Ensures the business recoups costs if an executive leaves early.
  • Tax deductions on bonus payments.
• Executive Benefits:
  • Guaranteed retirement and death benefits if they remain with the company.
  • Reduces financial risk while still offering long-term growth potential.
  • Can access cash value after vesting.

Why Every Business Should Implement an Executive Bonus Plan

A Section 162 Executive Bonus Plan is an essential tool for businesses looking to reward and retain top talent while also optimizing tax efficiency. Here’s why every company should consider implementing one:

1. Significant Tax Advantages for the Company

• Premium payments are tax-deductible as long as they are considered reasonable compensation.
• Unlike other deferred compensation plans, there are no complex IRS restrictions or contribution limits.
• No ongoing liabilities for the business once payments are made.

2. Attract and Retain Key Executives

• Provides a competitive advantage in executive compensation packages.
• Retains high-value employees by offering long-term financial security.
• Can be structured with vesting schedules or conditions to ensure executives stay with the company.

3. Protect the Company’s Financial Interests

• If structured with a company-owned policy, the business retains control over the asset.
• Policies can be designed to provide liquidity for business continuity in case of an executive’s unexpected death.
• The plan can be customized to fit the company’s financial strategy and retention goals.

Maximizing Benefits: Double Tax Strategy for Business Owners

Business owners can also structure a Section 162 Plan to maximize tax efficiency and create personal wealth. Here’s how:

1. The Company Funds the Policy – The business pays premiums on a life insurance policy for the owner, which is a deductible expense.
2. The Owner Pays the Income Tax – Since the premium payments are considered compensation, the owner must pay income tax on the amount.
3. Using a Policy Loan to Offset Taxes – The owner takes a loan from the policy’s cash value to cover the income tax liability. Unlike direct compensation, this keeps the full value of the bonus intact and growing within the policy.
4. Long-Term Tax-Free Growth – The policy’s cash value continues to grow tax-deferred, and distributions can be taken tax-free in retirement.

For example, you fund a policy with $100,000 per year as part of an executive bonus, you take a policy loan from the Insurance company to offset your personal income tax, while not touching the money inside your policy. Your money is still growing tax deferred and still accessible tax free in the future.

This loan is typically not repaid, because the interest is just deducted from your death benefit. This is incredibly powerful because you are essentially using your money twice and not using your own money to pay the income taxes from the bonus.

In traditional cash bonuses, you’d have to pay the taxes out of the bonus, essentially reducing it by 30-40%. Afterwards, you could then invest the money, which would typically get taxed again at some point. Understanding this concept is incredibly powerful.

This approach allows business owners to reduce taxable income today, leverage life insurance as a tax-efficient retirement tool, and protect wealth for future generations—all while maintaining full control over their funds.

Executive Bonus vs. Traditional Cash Bonus: The Advantage Is Clear

A traditional cash bonus is taxed as ordinary income, meaning an executive may lose 30-40% of the bonus to taxes immediately. In contrast, using a life insurance policy under an Executive Bonus Plan ensures that the full bonus amount stays intact, grows tax-deferred, and can be accessed tax-free.

Bonus Type	Immediate Tax Deduction for Company?	Taxed as Income to Executive?	Tax-Free Growth?	Retirement Income Benefits?
Traditional Cash Bonus	✅	✅	❌	❌
Section 162 Life Insurance Bonus	✅	✅	✅	✅

Conclusion: A Must-Have Strategy for Businesses and Executives

The Executive Bonus Plan under IRS Code 162 is one of the most effective ways to reduce business taxes, attract and retain key executives, and build long-term wealth. Whether structured as a standard bonus, a split-dollar arrangement, or a company-owned retention strategy, it provides unmatched financial benefits.

For business owners, leveraging this strategy can create a powerful wealth-building tool while maintaining financial control. For executives, it offers a tax-efficient way to grow wealth, protect their families, and secure a comfortable retirement.

Every business looking to optimize executive compensation should strongly consider implementing a Section 162 Plan. It is a strategic, tax-advantaged solution that benefits both the company and the executive—ensuring financial growth, protection, and retention in an increasingly competitive marketplace.

If you are interested in implementing this strategy into your company and would like to see your very own numbers, feel free to contact us.

For more business planning articles, check out:

• The Power of Life Insurance for Business Owners
• Reduce Capital Gains with an Installment Sale
• Business Continuity Simplified: The Role of Buy-Sell Agreements