Under an executive bonus arrangement (also called a Section 162 arrangement) the employer pays the premium on a policy the executive owns.  The premium amount is deductible to the corporation and is included in the employee's gross income as compensation.  Additional amounts can be bonused by the employer to cover the taxes owed by the executive (a "double bonus" arrangement).

 

The employer can easily provide life insurance to key employees on a selective basis.  Executive bonus arrangements are generally not subject to Department of Labor restrictions so there are no nondiscrimination requirements.

 

If desired, the executive bonus arrangement can limit the executive's access to policy cash values for a specific period of time - usually a set period of years or until retirement.  A restrictive agreement is placed on the policy preventing the executive from surrendering the policy for its cash value, assigning the policy as collateral security, or changing ownership of the policy without employer consent until the predetermined time.

 

Though the employer controls the access to the cash value, values can never revert to the employer.  The employer merely has the right to stop the employee from accessing or depleting the cash values in the policy.

 

A restrictive agreement satisfies the employer's objectives in many situations.  Where, however, the employer wishes to create some form of cost recovery or vesting, a restrictive agreement alone is not enough.  An employment contract must be used to set out the vesting schedule.

 

An employment contract between the employer and employee will allow the employer to recover premiums paid under an executive bonus arrangement.  This contract more fully guarantees retention of the employee since the executive agrees to repay all or part of the bonuses if he or she leaves the employer before retirement or a specified period of time.

 

Golden handcuffing is done with a vesting schedule requiring the employee to continue working for the employer until some point in the future.  If the executive terminates his or her employment before the vesting date specified in the employment contract, the employer will be entitled to receive back its bonus payment to the extent the employee is not vested. 

 

When the executive terminates before vesting, the employer's right to recover its contributions is based solely on this employment contract.  Repayment is not secured by the life insurance policy.  The restrictive agreement only provides incentive for the executive to comply with the terms of the contract, it does not give the employer any right to the policy cash values.  Repayment will be taxable income to the employer since the bonus was deducted when originally paid by the employer. 

 

A variable life insurance contract can be used with an executive bonus arrangement.  The agreement does not restrict the employee's investment choices, just the employee's access to the money.  Because the ultimate cash value amount is uncertain, consideration should be given to a repayment obligation amount under an employment agreement.  Even though the ultimate cash value could be less than the amount of the bonuses, the vesting schedule should not be tied to the life insurance.

 

Executive bonus arrangements are flexible nonqualified compensation arrangements for owners and key employees that provide the corporation with a current tax deduction.  By adding a restrictive agreement on the policy and an employment contract, executive bonus arrangements give the corporation a current income tax deduction while providing it with sufficient control to encourage the executive to remain with the company.