How To Set Up An Executive Bonus Plan Using Life Insurance
Running a business is fun. Sure, it has its challenges, but you wouldn’t trade it for the world. Of course, there are some things you wish you could change. For example, you want to reward the best and brightest at your company. The problem is that ERISA laws prevent you from discriminating against employees. In other words, You can’t just give an extra contribution to your key employees’ 401(k) plan. Here’s what you can do though: set up a non-ERISA qualified executive bonus plan.
The Executive Bonus Plan
An executive bonus plan can easily be set up by following the rules outlined in IRS code section 162. This section allows you to issue a bonus as deductible compensation for services. The bonus needs to be “reasonable” according to the IRC. However, there is a lot of flexibility in regards to what constitutes a “reasonable” bonus.
Using Life Insurance
Life insurance is often used in an executive bonus plan because it’s simple to set up, doesn’t need to conform to various ERISA requirements if it’s outside of a retirement plan, and it allows you a great deal of flexibility in regards to contribution amounts.
The way this works is simple. You define an amount of money you want to pay out as a bonus. This bonus is paid every year as compensation to the employee. Typically, a separate legal agreement is drawn up that binds the employee in some way – preventing him from using the funds before a certain date or time.
In exchange for his service to the company, the employee is rewarded with the bonus which is usually fully payable at his retirement. It’s one way that employers have traditionally used to acquire the best talent in their industry.
The life insurance policy is often set up as a high cash value insurance policy. In other words, it’s a policy meant primarily for cash value accumulation. This means that participating whole life, or high cash value universal life insurance is often used as the financial vehicle.
For whole life, a 10-pay or 20-pay whole life may be used. Alternatively, a straight whole life, with the addition of a paid-up-additions rider may be used. For universal life, “maximum cash value/minimum death benefit” is selected for the policy prior to its issue.
Considerations
While an executive bonus plan is a great way to reward key employees in your company, it isn’t without risk. First, your company has to be generating sufficient revenues to justify a yearly, ongoing, bonus. Second, your company needs to establish a legal contract with the employee to ensure the employee provides sufficient service to the company before taking the bonus. Finally, life insurance doesn’t always offer the most attractive growth rate when compared to investments, so you and the employee must be willing to wait 20 to 30 years for the policy to show substantial cash value accumulation.
