Section 162 executive bonus plans: reward key people, deduct every dollar
A Section 162 plan is the simplest executive benefit there is: your business pays a bonus a key employee uses to buy a life insurance policy they own. The company deducts the bonus; the employee keeps the coverage, the cash value, and the portability. Here’s exactly how it works:
What is a Section 162 executive bonus plan?
A Section 162 executive bonus plan is one of the simplest, most flexible ways to reward and retain a key employee. The business pays the employee a bonus, and the employee uses it to buy a permanent life insurance policy that they personally own. (In practice, the employer often pays the premium directly to the insurer and reports it as income on the employee’s W-2.)
The name comes from IRC §162(a), which lets a business deduct ordinary and necessary compensation. As long as total pay is reasonable, the bonus is fully deductible to the employer — just like salary. The employee reports the bonus as taxable income under §61.
What the employee gets is genuinely theirs: a death benefit for their family, tax-advantaged cash value they can tap for retirement, and a policy that’s fully portable if they ever leave. Unlike a qualified plan, a 162 plan is selective by design — you choose exactly who participates, with no IRS approval and minimal paperwork.
It’s the executive-benefit equivalent of a clean, deductible raise that builds lasting value — and it can be dialed up with a tax gross-up or retention restrictions, as the designs below show.
The company gives a key employee a deductible bonus; the employee buys and owns a life insurance policy with it. The business writes off the cost, and the employee walks away with coverage and cash value they keep — even if they leave.
Why employers use it
Full deduction now. The bonus is deductible when paid — no waiting like deferred comp.
Pick who plays. Reward one rainmaker or your whole leadership bench — no discrimination testing.
Almost no red tape. No IRS approval, no qualified-plan filings, minimal administration.
Real value for the employee. Death benefit, cash value, and full portability.
Retention on tap. Add a restrictive endorsement for golden handcuffs.
How a Section 162 plan works
Set it up once with a short agreement, and it runs on your normal payroll — no government approval required.
Choose & document
Select the key employees and put a one-to-three-page bonus agreement in place stating the amount, timing, and any restrictions.
Employee buys the policy
The employee applies for and owns a permanent life insurance policy on their own life and names their beneficiary.
Employer bonuses the premium
The business pays a bonus equal to the premium (and reports it on the W-2), deducting it under §162 as reasonable compensation.
Employee builds value
Cash value grows tax-advantaged for retirement, and the family is protected by the death benefit — the policy stays with the employee.
Section 162 plans: the pros and the cons
It’s the simplest, most deductible executive benefit going — but the bonus is taxable to the employee, and you give up control unless you add a restrictive endorsement.
Advantages
- +
Immediate, full deduction. The employer writes off the bonus when paid under §162 — no deferral.
- +
Selective. Reward chosen key people only; no nondiscrimination testing or coverage rules.
- +
Simple to run. No IRS approval, no qualified-plan filings, light administration.
- +
Real, portable value. The employee owns the policy, its cash value, and the tax-free death benefit.
- +
No contribution limits. Unlike qualified plans, there’s no cap — only the reasonable-compensation standard.
- +
Flexible. Works for any entity type and can be tailored employee-by-employee.
Drawbacks & risks
- −
Taxable to the employee. The bonus is W-2 income subject to income tax and FICA/FUTA — unless you gross it up (which costs the employer more).
- −
Employer loses control. Once bonused, the employee owns the policy — no built-in handcuffs without a restrictive endorsement.
- −
No cost recovery. Unlike split-dollar or deferred comp, the employer doesn’t get its money back.
- −
Reasonable-compensation limit. The deduction can be challenged if total pay is excessive for the role.
- −
Owner-employee nuances. >2% S-corp shareholders and sole proprietors face different (or no) deductibility — coordinate with your CPA.
- −
Policy performance risk. The employee bears it; an underfunded or underperforming policy can fall short.
How it compares to other executive benefits
A Section 162 bonus, split-dollar, and nonqualified deferred comp all use life insurance to reward key people — but they differ on deduction timing, cost recovery, and retention.
| Factor | Section 162 Bonus Employee owns the policy | Split-Dollar Shared policy & benefits | Nonqualified Deferred Comp Promise to pay later |
|---|---|---|---|
| Who owns the policy | The employee | The owner or insured (varies by regime) | The employer (informally funded) |
| Employer tax deduction | Immediate When the bonus is paid (§162) | Generally none currently | Deferred When benefits are paid |
| How the employee is taxed | On the bonus now (§61) | On the economic benefit or loan interest | When benefits are received |
| Employer recovers its cost | No | Often (loan repaid / owner keeps policy) | Yes (employer owns the asset) |
| Golden handcuffs / vesting | Only with a restrictive endorsement (REBA) | Via vesting or rollout terms | Strong forfeiture provisions |
| Complexity & ERISA | Simplest minimal ERISA, no IRS approval | Moderate | Complex §409A, top-hat rules |
| Portability for the employee | High they own it | Varies by regime | Low employer asset |
| Best fit | Simple, selective reward & retention | Leveraged death benefit & estate planning | Deferring large comp with strong handcuffs |
A Section 162 bonus is the simplest of the three executive-benefit tools — fully deductible to the employer and fully owned by the employee. Compare the two split-dollar regimes in depth on the economic benefit and loan regime pages. The right tool depends on your goals for deduction timing, cost recovery, and retention — confirm the design with your attorney and CPA.
Single bonus, double bonus, or restrictive (REBA)
The same core plan can be dialed in three ways — from the leanest cost to the strongest retention.
Single Bonus
The employer bonuses the premium amount; the employee covers the income tax out of pocket. The leanest cost for the business.
- + You want the lowest employer cost
- + The employee can absorb the tax
Double Bonus (gross-up)
The employer pays an extra bonus to cover the tax, so the employee has no out-of-pocket cost. The full amount is still deductible.
- + You want a tax-neutral benefit for the employee
- + Maximum perceived value matters
Restrictive (REBA)
A restrictive endorsement limits the employee’s access to cash value until they vest (often 5–10 years) — golden handcuffs for retention.
- + Retention is the priority
- + You want a deduction and some control
An estate-planning tip: if the policy is large, the employee may have an irrevocable life insurance trust (ILIT) own it, keeping the death benefit out of their taxable estate. Each bonus is then treated as a gift to the trust — plan the gifting with your attorney.
Model the bonus and the policy
A bonus plan is built on a permanent life insurance policy. Our funding calculator helps you gauge the right coverage, then connects you to instant-decision quotes — and an advisor can model the single-vs-double-bonus tax math.
The Funding Calculator
Whether the goal is key-person retention, supplemental retirement income, or both, the right premium starts with a clear coverage number. Our calculator sizes coverage per insured — a useful starting point you can refine with your advisors, including a gross-up for a double-bonus design.
- ✓ Sizes coverage per key employee
- ✓ A starting point for single- or double-bonus design
- ✓ Flags any policy set below the calculated need
- ✓ Connects straight to instant-decision quotes
Illustrative only at a 35% bracket — not a quote.
Section 162 executive bonus plan FAQ
Reward the people who run your business
A Section 162 plan is one of the quickest executive benefits to set up. Talk it through with a licensed expert, then size the policy behind it.
References
26 U.S.C. §162 — Trade or business expenses; deduction for reasonable compensation. Cornell Legal Information Institute. law.cornell.edu
Treas. Reg. §1.162-9 — Bonuses to employees treated as deductible compensation. Cornell Legal Information Institute. law.cornell.edu
26 U.S.C. §61 — Gross income defined (the bonus is taxable income to the employee). Cornell Legal Information Institute. law.cornell.edu
26 U.S.C. §101(a) — Exclusion of life insurance death benefits from gross income. Cornell Legal Information Institute. law.cornell.edu
26 U.S.C. §83 — Property transferred in connection with the performance of services (relevant to restrictive/vesting arrangements). Cornell Legal Information Institute. law.cornell.edu
Important disclosures
This site is for educational purposes, and QB Insurance LLC, nor its agents, provide tax or legal advice. We are trying to provide relevant information for funding a buy-sell agreement with life insurance, long-term care and/or disability insurance.
This page is provided by Quote-Bot for general educational purposes only and reflects information available as of its publication. A Section 162 executive bonus plan has income, employment (FICA/FUTA), and — for owner-employees — entity-specific tax consequences. It is not legal, tax, accounting, or investment advice, and no attorney-client or fiduciary relationship is created by reading it. The employer’s deduction depends on the bonus being reasonable compensation. Before adopting any executive bonus arrangement, consult your own attorney and CPA. Life insurance product availability, underwriting outcomes, and guarantees vary by applicant, carrier, and state.
