How does a Section 162 executive bonus plan work?

A Section 162 executive bonus plan is one of the simplest ways a business can help a key employee — or the owner — own a permanent Life Insurance policy. The company pays the person a cash bonus, and the person uses that money to buy a permanent Life Insurance policy that they personally own. The business writes off the bonus as compensation under Section 162 of the Internal Revenue Code, the employee reports the bonus as taxable income, and the employee walks away owning the policy, its cash value, and the right to name the beneficiary. It is sometimes called a 162 plan, an executive bonus plan, an IRC Section 162 executive bonus plan, or executive bonus plan life insurance — all the same idea.

Because the employee owns the policy instead of the company, a Section 162 executive bonus plan sidesteps the employer-owned Life Insurance tax rules that complicate company-owned coverage. That simplicity is exactly why so many Charlotte-area business owners use it to reward and keep the people who drive their business.

What is a Section 162 executive bonus plan?

An executive bonus plan under IRC Section 162 is not a special product you buy off a shelf. It is an arrangement built around an ordinary permanent Life Insurance policy. "Section 162" simply refers to the part of the tax code that lets a business deduct ordinary and necessary compensation it pays to employees. When a company pays a bonus for the specific purpose of funding an employee's personally owned Life Insurance, the bonus is deductible compensation just like salary — and the employee ends up with permanent coverage and a cash-value account they control.

The plan is deliberately selective. Unlike a 401(k) or another qualified retirement plan, an employer can offer a life insurance executive bonus plan to one hand-picked executive, a small group of key people, or just to itself as the owner — with no requirement to include everyone on payroll. There is also no formal ERISA plan document to maintain the way a qualified plan requires, which is a big part of the appeal.

How a Section 162 executive bonus plan works, step by step

1. The business selects the key person. This is usually a top producer, a critical manager, or the owner. The employer decides how much coverage and cash value it wants to help fund.
2. A permanent Life Insurance policy is applied for — owned by the employee. The employee is the policyowner and the insured from day one, and the employee names their own beneficiary (often a spouse, children, or a trust).
3. The business pays a bonus. The employer pays the employee a bonus equal to the premium (or, in a double-bonus design, the premium plus the tax — more on that below).
4. The premium gets paid. The bonus dollars go toward the annual premium on the employee-owned policy.
5. The business takes the deduction. The employer deducts the bonus as ordinary and necessary compensation under IRC Section 162, subject to the "reasonable compensation" limit.
6. The employee reports the bonus as income. Because it is compensation, the bonus is taxable income to the employee, just like a cash bonus.

From that point on, the employee owns everything: the death benefit, the cash value that builds inside a permanent policy, and full control of the contract. If they leave the company, the policy goes with them — there is nothing for the employer to unwind.

The tax picture: who deducts, who pays, who collects

The tax treatment is where an executive bonus plan life insurance arrangement is most often misunderstood, so it is worth being precise.

• The premium itself is not what gets deducted. Personal Life Insurance premiums are never tax-deductible. What the business deducts is the bonus compensation it pays under Section 162 — and that bonus happens to be used to pay a premium. The distinction matters: the deduction is for wages, not for insurance.
• The bonus is taxable to the employee. The person receiving the bonus pays ordinary income tax on it, because it is compensation.
• The deduction is capped by "reasonable compensation." Total pay (salary plus the bonus) has to be reasonable for the work performed; an unreasonably large bonus can lose its deduction.
• The death benefit is generally income-tax-free. Like most Life Insurance, the death benefit paid to the employee's beneficiary is generally received free of federal income tax.

Single bonus vs. double bonus (the "gross-up")

Because the bonus is taxable, an employee who receives exactly enough to cover the premium still owes income tax on that amount — meaning they either dip into their own pocket for the tax or fund a slightly smaller premium. Many employers solve this with a double bonus, also called a gross-up: the company increases the bonus so it covers both the premium and the income tax the employee owes on the bonus. The employee nets the full premium at no out-of-pocket cost, and the larger grossed-up bonus is also deductible to the business within the same reasonable-compensation limits.

Why business owners choose a Section 162 plan

• Simplicity. There is no qualified-plan paperwork and no ERISA plan document to maintain. In many cases the "plan" is a short bonus agreement plus an ordinary Life Insurance application.
• Selectivity. The owner can reward one key person or a chosen few — it does not have to be offered to every employee, unlike a retirement plan.
• The employee owns it. The key person gets permanent coverage they control, with cash value they can potentially borrow against later. That is a powerful recruiting and retention tool.
• A clean current deduction. The business gets to deduct the bonus now, as compensation.
• No employer-owned insurance tax trap. This is a major structural advantage, explained in the next section.

Section 162 plan vs. other executive benefit strategies

The defining feature of an executive bonus plan is that the employee owns the policy. Compare that to the other common ways a business uses Life Insurance, and you can see why the 162 plan is often the simplest choice:

With company-owned coverage such as key person insurance or corporate-owned life insurance, the premiums are not deductible, and a set of employer-owned Life Insurance rules (IRC Section 101(j)) require specific written notice and consent before the policy is issued — or the death benefit can become taxable to the business. A Section 162 executive bonus plan avoids that entire issue because the employee, not the employer, owns the policy. A split-dollar arrangement can do more sophisticated things (splitting cost and benefit between the company and the executive), but it is considerably more complex to document and administer. For many owners, the 162 plan delivers most of the retention benefit with a fraction of the paperwork.

Who is a Section 162 executive bonus plan best for?

An executive bonus plan under Section 162 tends to fit two situations especially well:

• Rewarding non-owner key employees. If you want to lock in a star manager or top producer, a 162 bonus gives them permanent, portable coverage funded by the company — a benefit they feel immediately.
• C corporation owners. Because a C corporation is taxed separately from its owner, the company's deduction for the bonus is a genuinely separate tax event from the owner's personal income — so the deduction carries real value.

A note for pass-through (S corporation and partnership) owners

If you own an S corporation or a partnership and you bonus yourself, the math is different. Because the business's profit and loss flow through to your own personal return, the deduction the business takes and the income you report can largely offset each other — so the net tax benefit of bonusing yourself can wash out. That does not make a 162 plan useless for a pass-through owner (it can still be a clean, simple way to fund personally owned coverage, and it works well for bonusing non-owner employees), but the tax efficiency looks very different than it does for a C corporation. This is exactly the kind of question to walk through with your CPA and a licensed agent before you set anything up.

Adding retention: the "restricted" or golden-handcuff version

A plain 162 plan gives the employee full control of the policy right away, which some owners worry about — what stops a key employee from taking the bonus-funded policy and walking out the door? A common variation adds a vesting schedule so the employee cannot access the policy's cash value until they have stayed a set number of years. This "restricted" or golden-handcuff design keeps the retention incentive strong while still letting the employee own the coverage. Exactly how it is documented varies, so it is worth designing with an advisor rather than off a template.

What a Section 162 plan does not do

• It is not a business deduction for insurance. Remember, the deduction is for compensation, not premiums.
• It is not tax-free to the employee. The bonus is taxable income; the double-bonus design manages that, but does not erase it.
• It is not a qualified retirement plan. There are no qualified-plan contribution limits, but also none of the qualified-plan creditor protections; it is a compensation arrangement, not an ERISA plan.
• It is not the right tool for every goal. If the aim is to fund a buyout between owners, that is a job for a buy-sell agreement funded with life insurance, not an executive bonus plan.

How this fits the bigger picture for a business owner

A Section 162 executive bonus plan is one piece of a business owner's Life Insurance strategy, not the whole thing. Most owners also need to think about protecting the business if a key person dies, funding a buyout if a co-owner dies, and covering their own family. If you want the wider view first, start with what kind of Life Insurance small business owners need, and if you have a partner, look at how to get Life Insurance on a business partner. An executive bonus plan slots neatly alongside those strategies once the foundation is in place.

Talk it through with The Jordan Insurance Agency

Executive benefit design touches tax, cash flow, and the specific carrier and policy you choose — so it pays to have someone who can shop multiple carriers and model the numbers with you. The Jordan Insurance Agency is an independent agency based in Charlotte, North Carolina that works with many highly rated Life Insurance carriers, which means we can compare policy designs and pricing rather than pushing a single company's product. We will sit down with you (and your CPA or attorney, if you like), explain a Section 162 executive bonus plan in plain English, and help you decide whether it — or a different structure — is the right fit for your business. There is never a fee to talk it through.

This page is general education only and is not tax or legal advice. The rules around executive bonus plans, deductions, and reasonable compensation depend on your specific situation and entity type — please confirm the details with your CPA or attorney before acting.