The Effectiveness of Executive Bonus Plans

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By Dale Edwards

2 minutes

Create year-to-year retention without a big financial commitment.

Sponsored by TriscendNP

While modern and innovative organizations strive to recruit and retain key leadership in a competitive landscape, supplemental retirement benefits—which are above and beyond traditional plans like 401(k)s and IRAs—can be a valuable tool. As publicly traded companies often use stock options to incentivize top employees, non-profit organizations and small to mid-size companies are more limited in their options. In this article we will be discussing executive bonus plans under Section 162 of the tax code. Bonus plans are another popular arrangement that uses insurance to provide tax-free earnings for retirement and death benefit coverage.

Executing the Process

First, the employer pays a bonus to the executive in exchange for service or performance milestones. The bonus is then immediately includable in compensation and taxes are withheld. The net proceeds are paid as a premium to a cash value-oriented life insurance policy that the executive owns. Due to the tax advantages of life insurance, the policy’s cash value grows tax-free, and the executive can borrow tax-free against the policy for retirement cash flow needs.

Benefits and Effectiveness

An organization looking to offer a simple, attractive and cost-effective benefit to key management is often a good candidate for executive bonus plans. Plans are “pay as you go,” so organizations can spread the cost over the future career of the executive. Additionally, the funds are going into a life insurance policy, rather than directly into the executive’s hands, so the funds are more likely to be saved for retirement. Within an executive bonus plan, there are certain life insurance products that offer collared investment options. These options track the performance of a major market index but are subject to a cap rate and a floor rate. These products can work very well for retirement assets because they offer market-competitive returns with limited downside.

Rewards of an Executive Bonus Plan

Executive bonus plans are rarely subject to vesting requirements since the payments are includable in the executive’s income each year. While otherwise very efficient, this can impact the retentive value of the plan, as it only creates incentives year-to-year, promoting short-term retention. If the executive terminates employment, they retain ownership of the policy, but the organization can immediately cease funding and have no further obligation under the plan.

Executive bonus plans are a versatile and efficient tool for organizations looking to reward and retain key leadership without a substantial financial commitment.

Dale Edwards serves as principal of CUES Supplier member TriscendNP. As a co-founder, Edwards’ vision is to take the experience and discipline from his investment banking background and provide unique products and services to the employee benefits sector. Mr. Edwards has used his extensive investment banking and M&A experience to invent numerous proprietary strategies.

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