Executive Bonus Plans: Using Life Insurance to Attract and Retain Key Employees
Attracting and retaining talented executives can be one of the biggest challenges for a growing business.
Salary matters, but highly valuable employees may also consider the overall benefits package when deciding whether to join a company or stay for the long term.
One strategy some businesses use is an executive bonus plan.
An executive bonus plan can allow an employer to provide an additional benefit to a selected employee, potentially including funding for a life insurance policy. It can be structured as a way to reward an executive while helping the business compete for experienced talent.
For business owners, understanding how these arrangements work can help determine whether an executive bonus plan fits into the company's compensation and retention strategy.
What Is an Executive Bonus Plan?
An executive bonus plan is an arrangement in which a business provides additional compensation or benefits to a selected employee.
One common design involves the employer paying a bonus to the employee, who then uses the bonus to pay premiums on a life insurance policy.
The employee generally owns the policy, while the business provides the bonus used to help fund it.
This can give the executive an additional benefit beyond their regular salary and traditional employee benefits.
Because the employee typically owns the policy, the arrangement can provide the executive with personal financial protection while also serving as a retention incentive.
How Does an Executive Bonus Plan Work?
A basic arrangement can work like this:
Step 1: The employer identifies an executive or key employee.
Step 2: The employer establishes an agreement outlining the bonus arrangement.
Step 3: The employee applies for and owns a life insurance policy.
Step 4: The business provides a bonus to the employee.
Step 5: The employee uses the bonus to pay the policy premium.
Step 6: The employee continues to own the policy and generally controls the policy according to its terms.
The exact structure can vary, and tax and legal requirements should be reviewed before implementing the plan.
Why Would a Business Offer an Executive Bonus?
Businesses may use executive bonuses to accomplish several objectives.
Attract Talent
Competitive compensation can make it easier to recruit experienced executives.
A company that offers additional financial benefits may be more attractive to candidates comparing multiple opportunities.
Retain Key Employees
An executive bonus plan can be part of a broader retention strategy.
Employees may be more likely to remain with a company when they receive valuable benefits that complement their salary.
Reward Performance
A business may use bonuses to recognize executives who contribute significantly to company growth.
Provide Additional Benefits
An executive bonus can provide an employee with an additional financial benefit beyond traditional compensation.
How Does Life Insurance Fit Into the Strategy?
Life insurance is one of the most common products associated with executive bonus arrangements.
Depending on the policy, life insurance can provide:
Death benefit protection
Potential cash value accumulation
Tax-deferred cash value growth
Long-term financial planning opportunities
Permanent life insurance can be particularly relevant when the employer wants to provide a long-term benefit.
However, the policy should be selected based on the employee's financial objectives and the terms of the arrangement.
Who Owns the Policy?
One of the defining characteristics of a traditional executive bonus arrangement is that the employee generally owns the life insurance policy.
This can be attractive to the executive because the policy may remain theirs even if they eventually leave the company, depending on the terms of the arrangement.
The employee may generally have control over policy decisions allowed under the contract.
This differs from key person insurance, where the business typically owns the policy and receives the death benefit.
Executive Bonus vs. Key Person Insurance
These two strategies are often confused.
Executive Bonus Plan
The employee owns the policy and generally receives the benefit.
The business provides a bonus that can be used to fund premiums.
Key Person Insurance
The business owns the policy and is generally the beneficiary.
The purpose is to protect the company financially if the key person dies.
The two strategies can potentially be used together.
For example, a company could provide an executive bonus to a highly valued executive while separately maintaining key person insurance on that executive to protect the business.
What Is a Double Bonus?
A common variation is known as a double bonus.
Under a double-bonus arrangement, the employer provides a bonus large enough to help cover both:
The life insurance premium
The employee's income tax liability associated with the bonus
For example, if a business wants to provide a $10,000 life insurance premium but the employee owes taxes on the bonus, the company may provide a larger bonus so that the employee has enough after-tax money to pay the premium.
The exact amount depends on the employee's tax situation and the arrangement.
Are Executive Bonuses Taxable?
Generally, bonuses paid to employees are treated as compensation and can be subject to applicable income and payroll taxes.
If the business pays a bonus to an employee and the employee uses the money to pay life insurance premiums, the tax treatment of the bonus generally still applies.
This is one reason the structure should be reviewed with a qualified tax professional.
The tax treatment of the life insurance policy itself can be different depending on ownership and how the policy is structured.
Can the Business Deduct the Bonus?
An employer may generally be able to deduct compensation that qualifies as an ordinary and necessary business expense, subject to applicable tax rules and limitations.
However, the deductibility of compensation can depend on factors such as:
Amount of compensation
Reasonableness
Business purpose
Corporate structure
Applicable tax rules
Business owners should consult their tax professional before assuming that a particular bonus arrangement will receive a specific tax treatment.
Why Permanent Life Insurance May Be Used
Some executive bonus arrangements use permanent life insurance because the policy can potentially provide both a death benefit and cash value.
Depending on the policy, cash value may grow on a tax-deferred basis.
The executive may potentially access cash value during their lifetime through policy loans or withdrawals, subject to the policy's terms and tax considerations.
However, accessing cash value can reduce the policy's available benefits and may create tax consequences if the policy later lapses or is surrendered.
Life insurance should therefore be evaluated as a long-term strategy rather than simply as a savings account.
Executive Bonus Plans and Retention
One potential advantage of an executive bonus plan is that it can provide a valuable benefit directly to the employee.
Businesses may choose to combine an executive bonus with other retention strategies, such as:
Performance bonuses
Retirement plans
Stock compensation
Deferred compensation
Health benefits
Paid time off
Professional development
The objective is to create a compensation package that encourages talented employees to remain with the organization.
What About Leaving the Company?
Because the employee generally owns the policy in a traditional executive bonus arrangement, the employee may retain the policy even if they leave the company.
However, the employer's future premium bonuses may stop.
The specific terms of the arrangement should clearly explain what happens when employment ends.
Businesses should consider whether the benefit is intended to be:
Fully vested immediately
Vested over time
Conditional on continued employment
Subject to another agreement
Legal counsel can help structure appropriate employment and compensation provisions.
Executive Bonus Plans for Small Businesses
Executive bonus plans aren't limited to large corporations.
Small and mid-sized businesses may also use additional compensation strategies to compete for talented employees.
For a smaller company that can't compete with a large corporation on base salary alone, a carefully designed benefits package can potentially help make the position more attractive.
A business owner might use an executive bonus to recognize an important manager, sales leader, technical specialist, or other high-value employee.
Executive Bonus vs. Retirement Plan
An executive bonus plan isn't necessarily a replacement for a qualified retirement plan.
Instead, it can complement existing benefits.
For example, a company might provide:
401(k): Broad retirement benefit for employees
Executive bonus: Additional benefit for selected executives
Life insurance: Potential personal protection and cash value
This can allow the employer to provide additional benefits without necessarily replacing its existing employee benefits.
Important Planning Considerations
Before implementing an executive bonus plan, consider:
Who qualifies?
How much will the business contribute?
Who owns the policy?
Who controls the policy?
What happens if the employee leaves?
What are the tax consequences?
Is the bonus deductible?
Is the policy appropriate for the employee?
What happens to the policy if the employee dies?
Does the arrangement need a written agreement?
Should the benefit vest over time?
These questions can help ensure the arrangement supports both the business and the executive.
Questions Business Owners Should Ask
Before establishing an executive bonus plan, consider:
Which employees are critical to the business?
What benefits would help retain them?
How much can the company afford to contribute?
Should the bonus be tied to performance?
Should the employee own the policy?
What type of life insurance is appropriate?
How will the bonus be taxed?
Can the business deduct the compensation?
What happens if the employee leaves?
Should the benefit vest over time?
How does the arrangement fit with the company's overall compensation strategy?
The Bottom Line
An executive bonus plan can be a flexible way for a business to provide additional compensation and financial benefits to selected employees.
When life insurance is used, the employee may receive a combination of personal life insurance protection and potential long-term cash value growth, depending on the policy selected.
For the employer, the arrangement can potentially help attract, reward, and retain valuable executives.
However, an executive bonus plan isn't the same as key person insurance or a traditional employer-sponsored retirement plan. The ownership, tax treatment, business purpose, and employee benefits can be different.
The right executive bonus strategy should be designed around the needs of both the business and the employee.
Before implementing one, business owners should work with qualified insurance, tax, and legal professionals to understand the applicable rules and structure the arrangement appropriately.
When properly planned, an executive bonus plan can become more than an additional compensation benefit—it can be part of a broader strategy for retaining the people who help drive your business forward while providing them with valuable financial protection.