Description and Approach
Documentation Required: If there are no restrictions placed on the executive bonus arrangement, the only documentation needed is a corporate resolution adopted by the employer’s board of directors. The resolution should establish the purpose for the bonus (for example, to help recruit, retain, and reward key executives). While it is not required, it may nevertheless be advisable for an attorney to formally document an agreement in writing between the employer and the executive that clearly defines the terms of the bonus arrangement.
Typically, the executive both applies for and owns the permanent life insurance policy. As the owner of the policy, the executive has the right to name the beneficiaries of the policy’s death benefit. However, the executive should not name the employer as beneficiary of the life insurance policy; otherwise the bonus would not be income tax deductible to the employer.
The employer may then either pay the premiums on the life insurance policy directly to the life insurance company or bonus the premiums to the executive, and the executive in turn writes the check to the insurance company. Sometimes, the employer will agree to pay an additional bonus amount to help the executive pay the income taxes on the bonus.
This plan is generally considered as a “double incentive.” In later years, the cash value of the permanent life insurance policy can potentially be accessed via policy loans or withdrawals to pay the additional income tax on the bonus amount, or for other needs. It is a fact that loans and withdrawals will decrease the cash surrender value and death benefit.