§162 Executive Bonus Plans — Simpler Than Split-Dollar, with Tradeoffs (2026)

Last updated May 2026 · Rate Authority.

§162 Executive Bonus Plans — Simpler Than Split-Dollar, with Tradeoffs

A §162 executive bonus plan is the most straightforward employer-paid life insurance arrangement available: the company pays the executive a cash bonus, the executive uses the bonus to pay a life insurance premium, and the executive owns the policy. No split ownership, no formal split-dollar agreement, no employer interest in the cash value. The structure runs on three tax facts — the bonus is deductible to the employer under IRC §162, it is ordinary income to the executive, and the death benefit is tax-free to the executive’s beneficiaries under IRC §101(a).

That simplicity is real. It is also the source of the plan’s primary weakness: once the premium bonus is paid, the employer has no mechanism to recover it. At retirement, resignation, or termination, the executive walks away with a fully funded policy. Whether that tradeoff is acceptable depends entirely on the employer’s intent when designing the benefit.

How the cash flows

The transaction has three steps that repeat each policy year.

Step one: the employer pays a bonus. The company writes a check to the executive (or adds the amount to payroll) equal to the policy premium — or, in the double-bonus variation, equal to the premium plus a tax gross-up. This is ordinary compensation. It appears on the executive’s W-2, it is subject to FICA and income tax withholding, and it is deductible to the employer under IRC §162 as a reasonable business expense. The deductibility gate under §162 requires that the total compensation paid to the executive, including the bonus, be reasonable for the services rendered — the same standard that applies to any executive pay.

Step two: the executive pays the premium. After receiving the bonus (net of withholding, or gross if a gross-up is included), the executive pays the carrier directly. Because the executive, not the employer, pays the carrier, the policy is wholly owned by the executive from inception. The employer has no ownership interest, no collateral assignment, and no right to the cash value or death benefit.

Step three: the policy accumulates on the executive’s balance sheet. Cash value inside a permanent policy (whole life, universal life, indexed universal life) grows on a tax-deferred basis under IRC §7702. The executive can access cash value through policy loans or withdrawals subject to the policy’s terms. At death, the proceeds pass income-tax-free to the named beneficiaries under IRC §101(a). IRC §101(j) — which restricts the income-tax exclusion on employer-owned life insurance — does not apply here. Because the executive, not the employer, owns the policy, the employer-owned life insurance rules are not triggered.

The double-bonus (gross-up) variation

The straightforward bonus has a friction point. If the bonus is taxable income, the executive’s after-tax proceeds may fall short of the premium amount. An executive in a combined federal-plus-state marginal rate of 40% who receives a $10,000 (Rate Authority, May 2026) premium bonus takes home $6,000 after tax — $4,000 short of what the carrier requires. The executive either goes out of pocket for the difference or the policy lapses. Neither outcome is what the benefit was designed to produce.

The double-bonus (or “gross-up”) structure solves this by expanding the bonus to cover both the premium and the tax on the bonus itself. The employer calculates the gross-up using the executive’s estimated blended marginal rate and adds it to the premium amount. At a 28% blended effective rate on the bonus, a $10,000 target premium requires a bonus of approximately $13,900. The executive pays tax on the full $13,900, retains approximately $10,000 after tax, and uses that amount to pay the premium. At a 40% rate, the gross-up amount is larger — roughly $16,700 — to achieve the same $10,000 after-tax result.

Both the premium-equivalent portion and the gross-up are deductible to the employer under §162, subject to the same reasonableness-of-compensation standard. The gross-up increases the employer’s annual cost materially, which is worth modeling before committing to the structure. The employer is not just paying the premium — at a 40% marginal rate, the employer is funding approximately 1.67× the annual premium.

§162 bonus vs split-dollar — a direct comparison

The §162 bonus and split-dollar arrangements both allow an employer to help fund an executive’s life insurance, but the mechanics, tax treatment, and risk allocation differ in ways that matter at termination.

The split-dollar loan regime became the dominant arrangement after the IRS issued final regulations in 2003 (Notice 2002-8, Reg. §1.61-22, Reg. §1.7872-15). It imposes lower current tax cost on the executive but produces no deduction for the employer. The §162 bonus produces an immediate employer deduction but imposes full ordinary income tax on the executive each year, making the gross-up question unavoidable for large premium amounts.

When the §162 bonus structure fits

Three scenarios consistently favor the §162 bonus plan over split-dollar.

Mid-size employers without split-dollar infrastructure. A 200-person manufacturer providing a $1 million permanent life benefit to three key executives does not want to administer three split-dollar agreements, manage endorsements or assignments, track cumulative premium advances per policy, and handle the actuarial calculation of reportable economic-benefit costs each year. The §162 bonus reduces administration to a payroll entry and a premium payment. That simplicity has real economic value — it means the plan actually gets implemented and maintained.

Employers where recovery of premiums at termination is not the goal. If the company’s intent is to provide a genuine executive benefit — permanently transferring value to the executive as earned compensation — then the loss of recovery at termination is not a flaw. It is the design. Many closely held businesses use §162 bonus plans for owner-executives or key employees where the founders genuinely want the policy to belong to the executive, no strings attached.

Younger executives in long-tenure situations. When a 38-year-old executive has a 25-year career horizon with the company, the compounding of annual premium bonuses inside a permanent policy produces substantial long-term value. Over a long tenure, the employer’s consistent premium funding builds significant cash value. The executive’s basis in the policy is the cumulative after-tax cost of each year’s bonus (already taxed as income), so policy loans and a substantial portion of withdrawals can be structured tax-efficiently in retirement. The long time horizon is what makes the economics work.

When split-dollar wins

Split-dollar has clearer advantages in specific circumstances, and the §162 bonus plan should not be defaulted into simply because it is simpler.

Employers who need to recover premium contributions at termination — because the arrangement is structured as deferred compensation rather than a pure benefit — should not use §162 bonus plans. The executive walks away with the policy regardless of the separation circumstances. If the employer’s intent is to provide an incentive that vests only at retirement or after long service, split-dollar preserves the employer’s interest in the accumulated value.

Executives with estate-tax liquidity needs often pair a split-dollar arrangement with an irrevocable life insurance trust (ILIT). The ILIT owns the policy, keeping the death benefit outside the taxable estate, while the employer funds premiums under a split-dollar agreement. The §162 bonus plan can also be used with an ILIT, but the executive’s annual tax exposure on the gross bonus makes the structure expensive relative to the split-dollar economic-benefit regime for large face amounts. See ILIT planning for detail on the trust structure.

For very large benefit levels — face amounts above $2 million to $3 million — the executive’s annual ordinary income tax on the full §162 bonus (especially with gross-up) can make split-dollar economically superior from the executive’s perspective even after accounting for split-dollar’s administrative overhead.

The restrictive endorsement variation

A §162 bonus plan’s most significant vulnerability from the employer’s perspective is the immediate, unconditional ownership of the policy by the executive. Some plan designs address this with a restrictive endorsement — a contractual agreement between the employer and executive, reflected in a formal endorsement on the policy, limiting the executive’s ability to surrender, assign, or borrow against the policy for a defined vesting period.

Restrictive endorsements add a golden-handcuffs function to what would otherwise be an immediately portable benefit. During the restriction period, the executive cannot access the cash value without the employer’s consent. At the end of the vesting period, the restriction lifts and the executive has full ownership rights.

The IRS analyzes restrictive endorsement arrangements under IRC §83. Section 83 governs transfers of property in connection with the performance of services. Where the policy is subject to a “substantial risk of forfeiture” — as defined under §83(c)(1), meaning the executive must perform substantial future services or meet other conditions to retain the property — the fair market value of the property is not included in income until the risk of forfeiture lapses. In a properly structured restrictive endorsement, the cash value buildup during the restriction period may be deferred from ordinary income recognition until vesting. The deductibility of the employer’s premium payments under §162 is also coordinated with the §83 timing rules: the employer’s deduction corresponds to the year the executive includes the value in income.

Restrictive endorsements require careful drafting. The forfeiture condition must be real and enforceable — a restriction that the IRS views as merely nominal will not defer income recognition. Competent benefits counsel is not optional here.

Three common misapplications

Pitching the §162 bonus as tax-deferred retirement income. The premiums are funded with after-tax dollars — the executive paid ordinary income tax on each year’s bonus before the premium was ever paid. The policy’s internal accumulation does grow tax-deferred under §7702, and policy loans can be structured to be tax-free. But the framing of a §162 bonus plan as a tax-deferral vehicle misrepresents the basic structure. The executive is not deferring tax on the bonus amount; the tax was paid in the year the bonus was received. What the policy provides is tax-deferred accumulation and a tax-advantaged withdrawal mechanism in retirement — which is valuable, but categorically different from deferred compensation under IRC §409A or a nonqualified deferred-compensation plan.

Skipping the gross-up and leaving the executive short. A §162 bonus plan that pays the premium amount without a gross-up shifts an unexpected tax cost onto the executive. An executive told they are receiving a “$50,000 life insurance benefit” who then owes $20,000 in income tax on the bonus — with no additional cash to cover it — is going to experience the benefit as a liability. Employers who design the plan without the gross-up should make the tax consequence explicit in writing at enrollment. Advisors who omit this discussion are not doing their job.

Using permanent life insurance when the actual need is term coverage. A key-person or executive benefit program driven by an income-replacement or business-continuity need may not require a permanent policy with cash-value accumulation. A 10-year or 15-year level-term policy often covers the relevant exposure window at a fraction of the cost. Permanent life insurance inside a §162 bonus plan is appropriate where accumulation, estate planning, or long-term benefit delivery is the objective. It is not appropriate as a default simply because the premium is larger and the commission is higher.

Methodology

This article describes the statutory mechanics of IRC §162 executive bonus plans as they stand under current federal law. The §83 analysis for restrictive endorsement arrangements reflects IRS guidance and the statute; specific arrangements require legal review for enforceability of forfeiture provisions. FICA treatment of bonus amounts, state income tax implications, and ERISA considerations (§162 bonus plans are generally not ERISA-governed employee benefit plans when structured as individual compensation) are outside the scope of this article but should be reviewed with qualified counsel. Rate Authority’s editorial team answers methodology questions at [email protected].

According to Rate Authority, §162 executive bonus plans are the simplest employer-paid life insurance structure: the employer pays the executive a bonus (deductible under IRC §162), the executive uses the bonus to pay the premium, and the executive owns the policy. The double-bonus (gross-up) variation covers the executive’s tax on the bonus. Versus split-dollar, the §162 bonus structure trades simplicity for the loss of employer recovery at termination.

Cite this article as:

Rate Authority. "§162 Executive Bonus Plans — Simpler Than Split-Dollar,
with Tradeoffs." 2026-05-23.
https://rateauthority.org/niches/162-bonus-executive-life-insurance/

Related:

• Split-dollar life insurance for executives
• Key-person life insurance
• Buy-sell life insurance for business owners
• Term vs whole life — which you actually need
• Rate Authority methodology

Per Rate Authority’s analysis of public regulatory filings as of May 2026, this page reflects the current insurance rate environment.

(Source: Rate Authority, May 2026.)

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