The Northwestern Mutual Life Insurance Company – Milwaukee, WI
EXECUTIVE BONUS PLANS
In Brief
Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company, Milwaukee, WI
(NM) (life and disability insurance, annuities) and its subsidiaries.
Executive Bonus Plan
An Executive Bonus Plan is an employee fringe benefit plan
that allows an employer to provide valuable life insurance for
selected employees in a manner that is tax-deductible for the
employer.
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Advantages to Employee:
• Provides valuable life insurance protection.
• Provides tax deferred cash value that is available for
emergencies, retirement or other accumulation goals.
• Minimizes the cost of life insurance.
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Advantages to Employer:
• Simple to install.
• May limit participation to key employees and select executives.
• Costs are tax-deductible.
• Promotes employee retention and recruiting.
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STRAIGHT BONUS – HOW IT
WORKS
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Straight Bonus – How It Works
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Straight Bonus – How It Works
• Employee owns and names the beneficiary of a policy insuring
his or her life, or the life of a third party.
• Employer pays the policy premium directly to Northwestern
Mutual. As an alternative, employer could bonus cash to the
employee and have the employee pay the premium to
Northwestern Mutual.
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Straight Bonus – How It Works
• Employee is income taxed on the amount of the premium
payment, and pays the tax with out-of-pocket funds. The
employee could take withdrawals from the policy (e.g., take
dividends in cash) to pay the tax on the premium.
• The plan can restrict employee’s access to cash value by
providing that, for a certain time period (e.g., 5 years), the
employee cannot withdraw cash or take a loan from the
policy without the employer’s consent (a “restricted § 162
bonus plan”).
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DOUBLE BONUS (GROSS-UP) –
HOW IT WORKS
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Double Bonus (Gross-up) – How It Works
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Double Bonus (Gross-up) – How It Works
The Employer pays the policy premium, and also pays additional
compensation to the employee so that the employee has funds
to pay the tax on the premium amount. The additional
compensation to pay the tax on the premium amount also
constitutes additional taxable income.
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Double Bonus (Gross-up) – How It Works
• To estimate the total compensation the employer must pay to
cover the premium amount plus the employee’s additional
taxes (so that the employee has no out-of-pocket cost), use
this formula:
amount of premium
1- employee's tax rate
= total compensation
• For example, if the premium is $10,000, and the employee is
taxed at a 30% rate:
10,000
1 - 0.30
10,000
=
0.70
= $14,286 total compensation
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FEDERAL TAX AND ERISA
CONSEQUENCES
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To The Employer
The employer can deduct the bonus/premium amount so long as
the amount of compensation is reasonable.
Internal Revenue Code (IRC) § 162.
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To The Employee
• The employee is income taxed on the bonus/premium amount.
IRC § 61.
• Cash values generally grow tax-deferred until distributions
exceed the cumulative premiums.
IRC § 72 and Cohen v. Comm’r, 39 TC 1055 (1963).
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To The Employee
• Amounts borrowed from the policy generally are not treated
as distributions unless the policy lapses or is surrendered.
IRC § 72.
• If the policy is a Modified Endowment Contract (MEC),
however, policy distributions and loans are treated as
distributions, and are taxed as first coming from any taxable
gain (with potential 10% penalty), and then as a tax-free
return of premiums. IRC §§ 72 and 7702A.
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Other Tax Consequences
• The cash bonus or premium amount is considered wages
subject to Social Security (FICA) and Federal
Unemployment Tax (FUTA).
• The death proceeds are generally not income taxed.
IRC § 101.
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ERISA Consequences
• A life insurance bonus plan is generally a welfare benefit plan
under ERISA.
• There should be a written plan, named fiduciary, funding policy,
administrative procedures, and claims procedure.
• In restricted § 162 bonus plans, the restriction should
terminate well before retirement to avoid classification as a
pension plan under ERISA.
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Disclosures
This presentation is not intended as legal or tax advice;
nonetheless, Treasury Regulations might require the following
statements. This information was compiled by The Northwestern
Mutual Life Insurance Company. It is intended solely for the
information and education of Northwestern Mutual Financial
Network, its customers and their own legal or tax advisors. It
must not be used as a basis for legal or tax advice, and is not
intended to be used and cannot be used to avoid any penalties
that may be imposed on a taxpayer.
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Disclosures
Northwestern Mutual and its financial representatives do not give
legal or tax advice. Taxpayers should seek advice regarding their
particular circumstances from an independent legal, accounting,
or tax advisor. Tax and other planning developments after the
original date of presentation may affect these discussions.
– To comply with Circular 230
Copyright © 2013 by The Northwestern Mutual
Life Insurance Company, Milwaukee, Wisconsin
www.northwesternmutual.com
22-3898-99
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