Navigate These Unprecedented Times by Engaging Your Key Executives

A 162 Bonus Plan Primer

Insight By
Gene LoVasco
Topic
Executive Benefits

The COVID-19 pandemic has significantly impacted our daily lives, including a swift and volatile impact on business operations and the financial markets. The challenging economic environment, coupled with little clarity as to when and how overall public health and business conditions will improve has resulted in high levels of uncertainty ― leading many companies to evaluate key aspects of their business and operations, including executive compensation and benefits.

More than ever, having an engaged and committed executive team is essential to ensuring a company’s survival, business continuity, and recovery. A critical component for attracting, engaging, and retaining executive talent is competitive executive compensation and benefits. As you assess your total rewards strategy, consider the strategic advantages of a 162 Bonus Plan.  

What Is a 162 Bonus Plan?

The name “162 Bonus Plan” refers to the Internal Revenue Code (IRC) Section 162(a)(1). 162 Bonus Plans are a tax efficient and cash efficient way for business owners or companies to provide additional benefits to key employees or executives of their choice. Using employer-funded life insurance policies, a 162 Bonus Plan provides death benefit protection to an executive and enables the executive to accumulate assets on a tax-efficient basis.

Why Would an Employer Establish a 162 Bonus Plan?

There are several objectives employers can achieve by using a 162 Bonus Plan:

  • Create a competitive edge to attract or retain key executives.  
  • Provide a benefit to specific, targeted executives.
  • Motivate job performance.
  • Help bridge the retirement income gap, commonly caused by contribution and discrimination testing limitations placed on qualified plans.  
  • Achieve flexibility in design, allowing each plan to be structured to meet specific objectives and executives’ needs.

How it Works

Employer's Role
  • Pays the premium on a life insurance policy for the insured executive.
  • Some plans allow for the executives to contribute to their policies via payroll deduction.
  • The employer is not a beneficiary and does not own any interest in the policy.
Executive's Role
  • Owns the life insurance policy.
  • Upon the executive's death, proceeds are fully payable to his or her designated beneficiaries as a tax-free death benefit.
  • Can receive income through tax-favored withdrawals and loans from the policy's cash value.
The Flow of a 162 Bonus Plan

What Features Can Be Customized?

One of the advantages of a 162 Bonus Plan is its flexibility. Specifically, an employer can customize:  

  • Eligibility
  • Contribution types (e.g., employer, employee)
  • Policy type (e.g., variable, indexed, fixed)
  • Contribution years
  • Limits (e.g., contributions, death benefits, issue ages)

What Are the Tax Implications?

At the Time of Contribution
  • For Employer: Recognizes contribution as a deductible compensation expense and then it is off the books.
  • For Executive: Makes contributions on an after-tax basis and it grows tax-deferred or tax-free if held until death.
At Time of Distribution
  • For Employer:  No impact.
  • For Executive: Can structure policy distributions to be tax-free via withdrawals and loans. Death benefits to beneficiaries are income-tax-free and can be structured to be estate-tax-free.

Should You Consider a REBA?

Some employers want to reward executives in a way that builds loyalty to the company by creating a “golden handcuff” ― adding certain limitations into the 162 Bonus Plan. Referred to as a Restricted Executive Bonus Arrangement (REBA), the limits can be established between the employer and the executive at the time the policy is issued and filed with the insurance company. A typical REBA may include the following restrictions:

  • The executive must receive the employer’s consent before accessing any available cash value.  
  • If the executive leaves the company, the executive must pay back a part or all the bonus that was used to fund the life insurance policy.  
  • The executive may not borrow against the policy’s cash value or pledge it as collateral.

What Are the Overall Advantages of a 162 Bonus Plan?

For the Employer
  • Program aids in attracting, retaining, and rewarding key executives.
  • Simple to implement, explain, and administer.
  • Can be offered on a selective basis; no minimum participation requirements.
  • Premium payments for tax-paying corporate sponsors are typically deductible.
  • Employer has the flexibility to delay or stop future payments.
  • Vesting schedules can be used to enhance retention.
  • No liability is carried on the corporate balance sheet.
  • No complicated tax, accounting, or compliance issues.
  • Not considered a non-qualified deferred compensation plan so is not subject to Section 409A.
For the Executive
  • Ability to leverage corporate “buying power” to access portable products, underwriting, and pricing commonly unavailable to individuals.
  • Owns policy and can name the beneficiary.
  • Cash values grow on a tax-deferred basis (tax-free if held until death).
  • Upon vesting, cash values can be accessed on a tax-free basis, subject to certain limitations, through withdrawals and loans to supplement retirement income.  
  • High flexibility related to timing of access to cash value.
  • Distributions from policies can occur before age 59-½ without premature distribution penalties.
  • No required minimum distributions at age 70-½ or thereafter.
  • Contributions to policies are not limited by qualified plan limitations.
  • Unlike deferred compensation plans, cash values are not subject to risk of forfeiture.
  • Upon the death of the executive, all policy proceeds are paid tax-free (federal) to his/her beneficiaries.
  • Assists in estate planning as death benefits can generally be arranged to be income and estate-tax-free.

Contact a LoVasco team member to learn more about how a 162 Bonus Plan would engage and motivate your key executives to drive your business forward during these challenging times.

Insight By
Gene LoVasco
President
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File Number

3342383.1

Topic
Executive Benefits
Published on

January 7, 2021

updated on

November 23, 2020

Disclosure

This article is for educational purposes only. The tax and legal references attached herein are designed to provide accurate and authoritative information with regard to the subject matter covered and are provided with the understanding that LoVasco Consulting Group is not engaged in rendering tax or legal services. If tax or legal advice is required, you should consult your accountant or attorney. LoVasco Consulting Group does not replace those advisors.

Securities and Investment Advisory Services offered through M Holdings Securities, Inc., a registered broker dealer and Investment Advisor, member FINRA / SIPC. LoVasco Consulting Group is independently owned and operated.

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LoVasco Consulting Group and their agents are presently licensed to sell traditional life insurance in Michigan as a resident producer and numerous other states as a nonresident producer. This site is not intended as an offer to sell securities, which may be done only after proper delivery of a prospectus and a client suitability review. Proper state registration is mandatory prior to conducting business in any state. Securities and Investment Advisory Services offered through M Holdings Securities, Inc., a registered broker dealer and Investment Advisor, member FINRA / SIPC. Check the background of this Firm and/or investment professional on FINRA's BrokerCheck. LoVasco Consulting Group is owned and operated independently from M Holdings Securities, Inc. LoVasco Consulting Group is a member of M Financial Group. Please click here for further details regarding this relationship.