Authored by: Erica Bourquin, CFP®
A business can have strong revenue, loyal clients, and a compelling growth plan, yet still face one of its most difficult risks: losing the people who make the enterprise work.
For some privately held companies, professional firms, and family-owned businesses, a small group of key employees may carry an outsized share of institutional knowledge, client relationships, operational judgment, and leadership continuity. When one of those individuals leaves, the cost is rarely limited to recruiting fees or a temporary vacancy. It can affect morale, client confidence, succession planning, and enterprise value.
This raises an important question for business owners: how can a company reward and retain key people without giving away equity or creating unnecessary administrative complexity?
One answer may be a Section 162 Bonus Plan.
What Is a Section 162 Bonus Plan?
A Section 162 Bonus Plan is an executive benefit strategy in which a business pays a bonus to a selected employee to fund a personally owned life insurance policy. The name comes from Internal Revenue Code Section 162, which generally allows businesses to deduct ordinary and necessary business expenses, including reasonable compensation for services rendered.
In practical terms, the company pays a bonus to an employee. The employee uses the proceeds of the bonus to purchase a life insurance policy that they then own. Because the employee owns the policy, the benefit can provide more than a current year reward. Depending on policy design, it may create family protection through the death benefit, and potential supplemental retirement accumulation through policy cash value, all while fostering a sense of long-term alignment between the employee and the company.
How the Strategy Works
A typical arrangement is straightforward.
- The business identifies one or more key employees.
- The company pays a bonus to each selected employee.
- The employee uses the bonus to pay premiums on a life insurance policy that he or she owns.
One important caveat is that the bonus is treated as taxable income to the employee, resulting in an increased income tax liability. Some companies use a “single bonus” approach, where the business pays only the premium amount. However, others use a “double bonus” approach, where the business pays an additional amount to help offset the employee’s tax cost. The right structure can be customized to suit the company’s goals, cash flow, tax position, and the employee’s overall compensation.
Why Retention Requires More Than Salary
In a competitive talent environment, salary alone may not create loyalty. Key employees often want to know that a business sees their contribution, values their future, and is willing to invest in their financial security.
This is especially relevant for executives who may not receive equity ownership since many business owners want to retain control, avoid dilution, and protect family ownership plans. However, business owners also recognize that top employees often think like owners, carry owner level responsibility, and expect compensation that reflects that role. A Section 162 plan can help bridge this gap. It allows the business to provide a selective financial benefit to specific key individuals without giving up their voting rights, profit interests, or ownership control.
Why Life Insurance Based Benefits Can Be Meaningful
Life insurance can serve several roles in an executive benefit plan. First, it can provide family protection. For a key employee with a spouse, children, or other dependents, the death benefit may help protect household financial security.
Second, permanent life insurance may build cash value over time. When properly structured, that cash value may be accessed later, subject to policy terms, tax rules, and the performance of the policy. This can support supplemental retirement planning, especially for executives who may be limited by qualified retirement plan contribution caps.
Third, the benefit is personal. The employee owns the policy, names the beneficiaries, and is left with a tangible asset connected to the company’s investment in them. This can make the benefit feel more meaningful than a short-term cash bonus that might be quickly absorbed into normal spending.
Section 162 Plans Versus Deferred Compensation Agreements
Deferred compensation arrangements can be powerful, but they can also be more complex. They often involve written plan documents, vesting schedules, timing elections, corporate balance sheet obligations, and compliance with rules such as Section 409A.
A Section 162 Bonus Plan eliminates future financial obligation and administrative burden for the company by paying a bonus to an employee in the present, and the employee enjoying the ownership of the policy as well as its present and future benefits.
This does not mean the plan should be casual. Proper design still matters, and businesses should thoroughly consider reasonable compensation limits, employment tax treatment, policy suitability, documentation, and whether any retention features are appropriate.
Planning Considerations for Business Owners
The tax treatment of a Section 162 Bonus Plan should be reviewed with the company’s tax advisor. In general, compensation must be reasonable and paid for services actually rendered to support deductibility under Section 162. The bonus is generally taxable to the employee, and taxable fringe benefits provided to employees are generally subject to reporting and employment tax rules.
Plan design should also account for:
- The employee’s age, health, family needs, and retirement goals
- The company’s cash flow and long-term compensation philosophy
- The type of insurance policy and funding schedule
- How long the company expects to support the plan
- Whether a retention agreement is appropriate
- How the plan fits with succession, continuity, and ownership objectives
As with all employee benefit planning, the decision to implement a Section 162 Bonus Plan should be made with care. Executive benefit strategies touch compensation, tax planning, risk management, and human capital planning and need to be integrated accordingly.
The Broader Succession and Continuity Connection
For business owners, retention is not separate from succession. A company that depends heavily on one founder or owner may need to develop the next layer of leadership well before a transition occurs.
Section 162 Bonus Plans may help support that process by rewarding the people who may carry the business forward. They can also send a clear message: the company is investing in leadership stability, client continuity, and long-term stewardship.
For family-owned businesses, this can be especially important. Not every key employee is a family member, and not every family member is prepared to run the company. A thoughtful executive benefit plan can help retain nonfamily leaders while preserving family ownership and control.
A Practical Tool for a Complex Talent Challenge
A Section 162 Bonus Plan is not the right answer for every company. It requires thoughtful design, ongoing review, and coordination with tax, legal, and insurance professionals. Yet for the right business, it may be a practical way to reward key employees, support their families, create potential supplemental retirement value, and strengthen retention.
At Granite Harbor Advisors, we believe business owners are best served when compensation planning is coordinated with their broader financial picture. Executive benefits should support the company’s goals, protect the owner’s interests, and recognize the key individuals who impact the enterprise.
In a market where talent is difficult to replace and ownership is not always meant to be shared, a Section 162 Bonus Plan can offer a flexible middle ground.