How Life Insurance Enhances Executive Bonus Plans

In today’s competitive talent landscape, business owners and executives are constantly searching for ways to attract, retain, and reward key employees. Traditional bonus structures and equity incentives may offer short-term motivation, but they often fall short in delivering long-term loyalty and alignment.

Enter the Executive Bonus Plan (EBP) — a flexible, tax-efficient tool that becomes even more powerful when paired with a properly structured life insurance policy.

While Executive Bonus Plans are not new, many business owners and their advisors overlook the critical role life insurance plays in enhancing their impact. In this article, we’ll explore how executive bonus plans work, why permanent life insurance is often the funding vehicle of choice, and what makes this strategy a smart move for growing businesses and successful executives alike.

What Is an Executive Bonus Plan?

An Executive Bonus Plan (also known as a Section 162 Plan) is a non-qualified arrangement where a business pays a bonus to a key employee, typically in the form of premium payments toward a life insurance policy.

Here’s how it works:

1. The business pays the premium on a policy owned by the employee.
2. The payment is treated as taxable income to the employee.
3. The employee receives valuable life insurance protection and builds tax-deferred cash value inside the policy.

Because it’s a non-qualified plan, it doesn’t require IRS approval or complex ERISA compliance, making it easy to implement with minimal administrative burden.

Why Life Insurance?

At first glance, life insurance may not seem like an obvious tool for executive compensation. But when you understand how permanent life insurance works — particularly whole life or indexed universal life — it becomes clear why it’s so effective.

Here’s what it brings to the table:

• Death benefit protection for the executive’s family
• Tax-deferred cash value growth that can be accessed later in life
• Flexible policy design that can be tailored to the compensation package
• Creditor protection in many states

When the policy is owned by the executive (not the company), they maintain full control over the asset — even if they leave the company in the future. That’s one of the key advantages of using a bonus plan instead of a restricted structure.

Executive Bonus Plan with Life Insurance vs. Other Incentive Strategies

Let’s compare a life insurance–funded bonus plan to a few other common incentive tools:

Enhancing the Plan with a Restricted Bonus (REBA)

While one of the strengths of an Executive Bonus Plan is that the employee owns the policy immediately, some employers want to ensure the executive remains with the company for a certain number of years. That’s where a Restricted Executive Bonus Arrangement (REBA) comes in.

In a REBA, the bonus plan includes a vesting schedule or other restrictions. These are typically enforced through a separate agreement that outlines the conditions under which the policy’s values can be accessed or transferred.

This adds a “golden handcuff” element — without shifting ownership of the policy to the business.

Example: Retaining a Key Executive with a Bonus Plan

Let’s say you run a closely held business generating $10 million in revenue. Your top operations executive is vital to your growth, and you want to ensure they stay committed over the next 10 years.

Instead of issuing phantom stock or restructuring salary, you establish a $50,000 annual Executive Bonus Plan using an indexed universal life insurance policy.

• The business deducts the $50,000 bonus each year
• The executive reports it as income but gains:
  • Life insurance protection of $2M+
  • Growing cash value they can access in retirement
  • Ownership of the policy, even if they eventually leave

You also implement a 5-year vesting schedule through a REBA. If the executive leaves before then, the policy’s access is restricted or forfeited, depending on your agreement.

This structure creates:

• Alignment between employer and executive
• Retention incentive over multiple years
• Valuable personal benefit for the executive

Tax Considerations

From a tax standpoint, the EBP is straightforward:

• Employer: Bonus payments are deductible as compensation.
• Employee: Bonus is taxed as ordinary income (withholding applies).

To offset the tax burden, many employers offer a double bonus—an additional amount to cover the executive’s tax liability. For instance, if the base bonus is $50,000, a total bonus of $80,000 may be issued to cover income taxes, leaving the executive with $50,000 net to pay the premium.

Because the employee owns the policy, the death benefit is income-tax-free to their beneficiaries under current tax law, and the cash value can grow tax-deferred and be accessed later via policy loans or withdrawals.

Customization and Flexibility

One of the biggest advantages of a life insurance – funded Executive Bonus Plan is how customizable it is. You can tailor the plan to:

• Vary by employee
• Include vesting provisions
• Adjust based on performance
• Use different types of policies based on needs and underwriting

This makes it an ideal tool for businesses with:

• A small number of highly compensated employees
• Limited appetite for ERISA compliance
• A desire to retain and reward without giving up equity

Who Should Consider This Strategy?

This strategy works particularly well for:

• Privately held businesses with fewer than 100 employees
• Professional service firms (law, accounting, medical practices)
• Owners who are looking to retain rainmakers without adding equity partners
• Executives who value long-term protection and cash accumulation

It’s also attractive to executives themselves, as it provides a portable, personally owned benefit that can outlive their time with the company.

Frequently Asked Questions

What type of life insurance is typically used?

Most plans use indexed universal life (IUL) or whole life insurance for stability and long-term growth. Term insurance isn’t suitable because it doesn’t accumulate cash value.

Can I offer this to myself as the owner?

Yes, business owners can participate in these plans, although care must be taken in C-corp structures to avoid unreasonable compensation concerns. It’s a common strategy for owner-operators.

How does this compare to a Restricted Property Trust?

An Executive Bonus Plan is more flexible and easier to implement, but it typically offers lower tax deductions and is designed primarily as a benefit—not a tax reduction vehicle. The Restricted Property Trust is a more sophisticated structure focused on tax deferral and wealth accumulation, often requiring a higher income threshold and longer commitment.

Is this strategy audit-proof?

There are no aggressive or gray areas in a basic EBP. It’s well-established under IRC Section 162. The key is documenting the bonus properly and ensuring the executive is the policy owner.

Final Thoughts

In a world where retaining talent is more competitive than ever, the Executive Bonus Plan offers a powerful mix of tax efficiency, simplicity, and real employee value. When funded with a well-structured life insurance policy, it becomes more than a bonus—it becomes a meaningful asset.

Whether you’re looking to reward a top executive, secure long-term loyalty, or create value without giving away equity, a life insurance–based EBP may be the solution you’ve been overlooking.

 

DISCLOSURE

TAX ADVICE

Any tax advice contained in this communication is not intended or written to be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

These materials are not intended to be opinions or advice on legal, tax, accounting, or investment matters. Private counsel should be consulted prior to application of this general information to specific situations.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.