What You Should Know About Executive Bonus Plans

In the business world, the most important resources are manpower. Human resources procurement is becoming strict, meticulous and specific. Companies did not just compete is sales but competition in hiring the best people also exist. They hire and retain talented, hard-working individuals who can help your business prosper and grow. The success of these businesses depends upon the efforts of its best people. Competitive compensation and benefits programs are a fundamental component to attracting professionals and retaining them for the future success of the business, especially those who occupy the key positions – the executives.

These groups of individual feel that investment for retirement plans are the most valuable saving program, to begin with. Executives are high earner employees and they want to provide protection to their family during their working years, starting a retirement saving is definitely must. As a procurement strategy, small to mid-sized companies to have an ability to attract and retain valuable executives by helping provide the additional benefits they seek.

In the United States taxation law, Section 162 of the Internal Revenue Code provides that:

"There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including - a reasonable allowance for salaries or other compensation for personal services actually rendered; "

It is in reference to this Code section that certain nonqualified plans, known as Executive Bonus Plans or referred as Section 162 Plans.  The executive bonus plan is a way in which business owners or employees provide additional supplemental benefits to key employees - pays the premiums on a permanent life insurance policy owned by an employee. This usually includes life insurance policy, death benefits and cash value accumulations as a retirement income supplement. 

US Supreme Court held that it only requires that the expense is one that is ordinary and necessary for that business. In one decided case, the term "necessary" was defined as an "appropriate and helpful [in] the development of the [taxpayer's] business." It is necessary to first ascertain the motive of the taxpayer in making the expenditures and determine the sufficiency of connection between the expenditures and his/her trade or business. If payments are inherently personal in nature, they are excluded in the deductions mentioned under Section 162.

How does it work?

The business will enter into an agreement to pay in full or part of the insurance premium owned by the executive. Then business owners will select executives who will receive this valuable benefit. The bonus is tax-deductible to the business within the limits of reasonable compensation and is taxed as ordinary income to the executive. It is important to note that the premium payment made by the business is deductible only because it is compensation, not because it is a nonqualified plan contribution. Some business owners try to tie bonus-reward system to meet the predetermined corporate goals and it works most effectively when the business clearly identifies the results it will reward.  

In the duration of employment, when the employee needed the money since the employee owns the policy he or she can access the cash before retirement, free from taxes he or she must surrender cash value from the insurance policy. If the employee died, his or her family will have life insurance benefit to make up for lost career earnings.

Advantages of Executive Bonus Plans

• It is simple to implement and easy to administer

• The business has the discretion which key employees they wish to reward.
• The bonus payment is considered as a deductible expense to the company.
• The key employee owns the insurance policy and he is able to name the beneficiary of the entire death benefit of the insurance policy.
• The key executive will have immediate access to policy cash value and access that cash value without income tax through policy loans and withdrawals unless there is a "restricted or controlled executive bonus",
• Executive bonus plans are not subject to "qualified plan limits".

Attracting and retaining the best people in the company actually is costly. Executive bonus plans as a reward system is a kind of cash flow commitment and some business are nervous about sustaining the amount needed. On the other hand, it is a simple and cost-effective way of motivating the talented and hard-working individuals who can help prosper and grow the business.