What is an Executive Bonus Plan?
In short, it’s a simple, affordable way for your business clients to reward select executives for long-term service. Business owners will pay premiums on a policy applied for and owned by the employee, so the employee can benefit from it later. These plans offer tax advantages for both the employer and the employee, and serve two roles:
1. As tax-advantaged supplemental income for the executive’s retirement, or
2. As death benefit coverage for beneficiaries, in case of the executive’s untimely death before retirement
The cost to your business client is typically just the after-tax cost of premium payments. They may choose to bonus the premium (single bonus) or the premium and the employee’s tax liability on the bonus (double bonus).
What are the advantages of Executive Bonus Plans?
For business owners:
- Premiums that fall within “reasonable compensation” guidelines are tax deductible
- They can select who they’d like to reward
- Long-term employment can be encouraged by offering rewards in exchange for achieving a certain milestone of employment
- Plans are generally exempt from IRS approval and reporting requirements
For their employees:
- They get the advantage of life insurance that they own, with little or no out-of-pocket expenses
- The employee controls the policy and beneficiary designation, even after leaving their job
- They enjoy peace of mind, knowing that their families are protected
- They can withdraw cash values if needed for emergencies, education funding, and more
Guidelines & restrictions
Here are a few things for your business clients to keep in mind:
- Employers can’t be beneficiaries of this insurance [IRC S264(a)(1)]
- The premium amount, paid by the employer, is considered additional compensation to the executive. (Subject to “reasonable compensation” rules)
- The plan should include a written agreement between the employer and the employee
- The covered executive must pay current income tax on the amount of the net premium paid by the employer
- Business owners can bonus the extra money needed to pay the tax, or it can be paid by the employee
Tailoring Executive Bonus Plans to meet business owners’ needs
These additional options let you customize plans to meet specific client objectives.
Restricted Executive Bonus Arrangement (REBA):
The REBA requires executives to get an employer’s consent to access cash values in the policy, or to make policy changes. Business owners can allow this requirement to be removed after a specified term, using a vesting schedule. Or they can keep it in place until the employee’s retirement.
Note: the IRS may deem the employer to have a beneficial interest in this type of plan, which could eliminate their tax deduction.
Leveraged Executive Bonus Arrangement (LEBA):
The LEBA is more like a combination of an Executive Bonus Plan and a Loan Regime Split Dollar Plan. The business owner pays the premium amount for a life insurance policy. The employee owns the policy, and the premium amount is reported as a taxable bonus. This way, the employer is providing a loan to the executive, to cover the employer’s tax cost on the annual bonus.
The executive is require under Loan Regime Split Dollar rules to pay interest based on the Applicable Federal Rate (AFR) back to the employer.* If the executive leaves employment or dies prematurely, the employer can obtain repayment of the outstanding loant through a collateral assignment against the policy. This comes from the policy values, or death benefit proceeds.
As a bonus to the executive, business owners may opt to forgive the outstanding loan balance when the employee either retires or reaches a certain length of employment.
Speak to your business clients about Executive Bonus Plans
Executive Bonus Plans help protect the success of your clients’ businesses. Talk to them today about these plans to reward top employees for their service while enjoying tax benefits for themselves.