1. No category

Executive
Bonus Plans
in brief
Executive Bonus Plan
An Executive Bonus Plan is an employee fringe benefit plan that allows an employer to
provide valuable life insurance for selected employees in a manner that is tax-deductible
for the employer.
Advantages to Employee: •Provides valuable life insurance protection.
•Provides tax deferred cash value that is available for emergencies, retirement or other
accumulation goals.
•Minimizes the cost of life insurance.
Advantages to Employer:
•Simple to install.
•May limit participation to key employees and select executives.
•Costs are tax-deductible.
•Promotes employee retention and recruiting.
Straight Bonus – How it Works
$ Premiums
Employer
Northwestern
Mutual
Life
Insur
Executive
•Employee owns and names the beneficiary of a policy insuring his or her life, or the life of
a third party.
•Employer pays the policy premium directly to Northwestern Mutual. As an alternative,
employer could bonus cash to the employee and have the employee pay the premium to
Northwestern Mutual.
•Employee is income taxed on the amount of the premium payment, and pays the tax with
out-of-pocket funds. The employee could take withdrawals from the policy (e.g., take
dividends in cash) to pay the tax on the premium.
•The plan can restrict employee’s access to cash value by providing that, for a certain time
period (e.g., 5 years), the employee cannot withdraw cash or take a loan from the policy
without the employer’s consent (a “restricted § 162 bonus plan”).
Double Bonus (Gross-up) – How it Works
$ Premiums
Employer
Northwestern
Mutual
$ Additional bonus to pay tax
Life
Insur
Executive
•The employer pays the policy premium, and also pays additional compensation to
the employee so that the employee has funds to pay the tax on the premium amount.
The additional compensation to pay the tax on the premium amount also constitutes
additional taxable income.
•To estimate the total compensation the employer must pay to cover the premium
amount plus the employee’s additional taxes (so that the employee has no out-of-pocket
cost), use this formula:
amount of premium
1 - employee’s tax rate
= total compensation
•For example, if the premium is $10,000, and the employee is taxed at a 30% rate:
10,000
1 - 0.30
=
10,000
0.70
= $14,286 total compensation
Federal Tax and ERISA Consequences
To the Employer
•The employer can deduct the bonus/premium amount so long as the amount of
compensation is reasonable. Internal Revenue Code (IRC) § 162.
To the Employee
•The employee is income taxed on the bonus/premium amount. IRC § 61.
•Cash values generally grow tax-deferred until distributions exceed the cumulative
premiums. IRC § 72 and Cohen v. Comm’r, 39 TC 1055 (1963).
•Amounts borrowed from the policy generally are not treated as distributions unless the
policy lapses or is surrendered. IRC § 72. •If the policy is a Modified Endowment Contract (MEC), however, policy distributions
and loans are treated as distributions, and are taxed as first coming from any taxable
gain (with potential 10% penalty), and then as a tax-free return of premiums. IRC §§
72 and 7702A.
Other Tax Consequences
•The cash bonus or premium amount is considered wages subject to Social Security
(FICA) and Federal Unemployment Tax (FUTA).
•The death proceeds are generally not income taxed. IRC § 101.
ERISA Consequences
•A life insurance bonus plan is generally a welfare benefit plan under ERISA.
•There should be a written plan, named fiduciary, funding policy, administrative
procedures, and claims procedure.
•In restricted § 162 bonus plans, the restriction should terminate well before retirement
to avoid classification as a pension plan under ERISA. This publication is not intended as legal or tax advice; nonetheless, Treasury Regulations might
require the following statements. This information was compiled by the Advanced Financial Security
Planning Division of The Northwestern Mutual Life Insurance Company. It is intended solely for
the information and education of Northwestern Mutual Financial Network, its customers, and their
own legal or tax advisers. It must not be used as a basis for legal or tax advice, and is not intended to
be used and cannot be used to avoid any penalties that my be imposed on a taxpayer. Northwestern
Mutual and its Financial Representatives do not give legal or tax advice. Taxpayers should seek advice
regarding their particular circumstances from an independent legal, accounting, or tax adviser. Tax
and other planning developments after the original date of publication may affect these discussions.
To comply with Circular 230
Copyright © 2009 by The Northwestern Mutual
Life Insurance Company, Milwaukee, WI
www.northwesternmutual.com
22-3898 (0497) (REV 0609)