How does it work?
The Section 162 Executive Bonus Plan is very easy to implement. The employee purchases and owns life insurance on his or her own life. The employer then pays the premiums to the life insurance company. The life insurance premiums are fully tax deductible to the employer as compensation to the employee under IRC Section 162. The life insurance premiums are taxable to the employee, and the employee owns the life insurance policy
including the life insurance policy's values. As the life insurance policy values grow, the employee benefits.
Some employers choose to pay not only the premium amount, but also the employees’ income tax on the life insurance premium amount. This second “bonus” pays the employee’s income tax on the first premium “bonus” and creates a “double bonus plan.” The employer should consider a formal resolution or document the corporate minutes to show that the life insurance premium payments are intended as compensation.
The company and the employee may also enter into a modification of ownership rights agreement. Even though the employee is the owner of the policy, a modification of ownership rights agreement may limit the control the employee has over the use of policy values. The employer may require that the employee is unable to access policy values for loans or withdrawals without written consent of the employer. There can also be a vesting period to help retain the employee with a Section 162 Executive Bonus Plan.