Executive benefits: what business owners should ask first

Why “executive benefit” is not one product

The term can describe very different arrangements: a taxable bonus that the employee may use toward life insurance, a split-dollar agreement dividing rights in a policy, or a deferred compensation arrangement with its own legal requirements. The employer’s objective might be retention, selective survivor benefits or competitive compensation. These are not interchangeable designs.

The first document should be an outline of the business objective, annual budget and desired retention period—not a policy proposal.

Questions that change the structure

Who owns the policy? Who is taxed and when? Is the benefit vested or forfeitable? What occurs if the executive resigns, dies, becomes disabled or is terminated? Is the employer receiving a future repayment, or making an outright bonus? Could the business continue the expense during a recession?

Answers influence whether the design makes sense and whether a lawyer or benefits specialist needs to evaluate retirement, employment and deferred-compensation rules.

Understanding a Section 162 bonus concept

In a basic bonus arrangement, an employer may pay a bonus that an employee applies toward individually owned insurance. The payment generally creates taxable compensation for the employee, and the employer’s deduction depends on applicable rules and reasonableness. It is inaccurate to call the entire arrangement “tax-free” without reviewing the actual facts. Other executive structures can be substantially more complicated.

Evaluate the illustration and the arrangement separately

A policy might perform materially worse than projected while the compensation arrangement still obligates the company to make payments. Review guaranteed versus non-guaranteed contract values, the exit provisions and the costs of administration. A simple cash bonus can sometimes accomplish a goal more efficiently than an elaborate insured strategy.

The board-level questions

A selective executive benefit is ultimately a compensation decision. Determine who is eligible, why the benefit is offered, whether it is tied to performance or retention, and how it fits with the company's broader employee philosophy. Model what the arrangement costs if the executive stays for ten years, leaves after eighteen months or dies during the first policy year.

A well-prepared proposal shows both the employer's cash obligations and the executive's potential taxes. It should explain what happens if the insurer changes crediting assumptions or an employee cannot maintain a policy after separation. Sophisticated-sounding structures do not excuse unclear economics.

A taxable bonus is often simpler than the label suggests

Section 162 of the Internal Revenue Code generally addresses deductions for ordinary and necessary business expenses, including reasonable compensation. A so-called Section 162 executive bonus arrangement does not turn compensation into a tax-free benefit automatically. In many common designs, the employer pays a bonus and the employee has taxable compensation while owning an insurance contract. Whether the employer can deduct the expense depends on the facts and applicable law.

More intricate arrangements—including split-dollar and certain deferred compensation programs—require specialists who understand the governing legal and tax requirements. The employer should be able to explain why added complexity produces a measurable benefit over a straightforward bonus or ordinary benefit.

The three documents that must agree

The employment or executive benefit agreement should state who receives what, under which conditions. The corporate compensation and payroll records should reflect that arrangement. The insurance application, ownership and beneficiary documents should then implement the same plan. If one document promises benefits that another contradicts, the design is not ready. The company also needs a responsible person to review funding and the program's continuing business purpose annually.