A Section 162 executive bonus plan is one of the simplest ways a business can reward and help retain a key employee: the company pays a bonus that funds a permanent life insurance policy the employee personally owns. The bonus is generally deductible to the company as reasonable compensation and taxable to the employee — clean mechanics, personally owned benefit, no complex plan document.
The mechanics
How it works, start to finish
The employer and employee agree on the benefit. The employer pays a bonus — usually equal to the policy premium — which the employee reports as income. The policy is issued to and owned by the employee, who names their own beneficiary and controls the cash value. Because the employee owns it, they keep the policy if they change jobs, and the employer's administrative burden is light compared with a formal deferred-comp plan.
Two designs
Single vs. double bonus
The one wrinkle is the tax the employee owes on the bonus. Two designs address it:
- Single bonus: the employer pays the premium amount; the employee pays the income tax on it themselves. Simple and lower-cost to the employer.
- Double bonus (gross-up): the employer pays an additional amount to cover the employee's tax, so the benefit costs the employee nothing out of pocket. More generous, more expensive.
For example, a company funding a $10,000 annual premium might add a bonus to cover the tax so the executive nets the full benefit — a hypothetical, round illustration, not a quote or a promise of any outcome.
Suitability
Where it fits
It fits a profitable business that wants to give a valued employee a meaningful, portable benefit without adopting a complex plan, and that's comfortable the employee owns the asset outright. When stronger retention is the goal — vesting schedules, clawbacks — a restricted version (REBA) or deferred compensation may be the better structure.
When this is the wrong tool — and what can go wrong
A Section 162 bonus is the wrong choice when:
- Retention is the real goal. The employee owns the policy immediately, so there's little to hold them if they leave — consider a restricted (REBA) design instead.
- The business isn't profitable enough to sustain the bonuses; an underfunded policy undermines the whole benefit.
- The employee doesn't want, or shouldn't be, buying permanent life insurance in the first place.
- It's presented with an aggressive policy illustration that makes the accumulation look guaranteed. It isn't.
- The deduction is assumed without confirming the total compensation is reasonable — a CPA question, not a given.
Common questions