Overview: Life insurance is not only a protection tool — it is a recruiting and retention instrument. Two specialized strategies, group carve-out plans and executive bonus plans, allow employers to offer select employees enhanced, tax-advantaged benefits that ordinary group coverage cannot provide.

Group Carve-Out Plans

Standard group term life insurance provided by an employer is governed by IRC § 79, which establishes an important threshold: the first $50,000 of employer-paid group term life insurance is tax-free to the employee. Coverage above $50,000 generates imputed income — the employee must report the "value" of that excess coverage as taxable income, calculated using IRS Table I rates. Table I rates escalate sharply with age, creating a growing annual tax burden for older, highly compensated executives.

A group carve-out plan resolves this problem by "carving out" key executives from the group plan for coverage above $50,000. Here is how it works:

The executive retains the $50,000 of tax-free group term coverage from the company's standard plan
The employer replaces all coverage above $50,000 with an individual permanent life insurance policy (typically universal life)
The employer funds the premiums through either a Section 162 executive bonus arrangement or a split-dollar agreement

Benefits for the executive:

Eliminates the growing Table I imputed income tax on large group term amounts
Creates portable coverage the executive keeps after leaving or retiring
Builds tax-deferred cash value that can supplement retirement income
Provides a tax-free death benefit for the executive's family

Benefits for the employer:

Not subject to non-discrimination rules for qualified plans — the employer can select exactly which executives receive the benefit
Functions as a "golden handcuff" retention tool
In split-dollar structures, the employer may recover premiums paid at the executive's retirement or death

Executive Bonus Plans (Section 162 Plans)

An executive bonus plan, also called a Section 162 plan, is one of the simplest and most flexible executive benefit structures. Under this arrangement:

The executive owns a permanent life insurance policy individually and designates their own beneficiaries
The employer pays the premium as a cash bonus to the executive
The bonus is reported as taxable W-2 compensation to the executive
The employer deducts the bonus as an ordinary business expense (IRC § 162(a)(1)), provided total compensation is "reasonable"

The genius of the structure is its simplicity: the employer takes an immediate deduction, the executive pays income tax on a relatively modest bonus amount, and in return receives a permanent, portable life insurance policy with growing tax-deferred cash value that can supplement retirement income.

Three variations:

Structure	Description
Single bonus	Employer pays only the policy premium; executive pays the income tax on that amount out of pocket
Double (grossed-up) bonus	Employer pays the premium plus an additional cash bonus designed to cover the executive's tax liability; executive has no out-of-pocket cost
Restrictive executive bonus (REBA)	Double bonus plus a restrictive endorsement filed with the insurer preventing the executive from accessing cash value or surrendering the policy without employer consent — the "golden handcuff" variation

Tax treatment:

Item	Employer	Executive
Bonus payment	Deductible as compensation (if reasonable)	Taxable income — reported on W-2
Cash value growth	Not applicable (employer not the owner)	Tax-deferred inside the policy
Death benefit	Not applicable (employer is not the beneficiary)	Paid to executive's named beneficiary income-tax-free

Worked Example: Executive Bonus Plan

Facts: A corporation establishes an executive bonus plan for its Vice President. The employer pays a $500,000 bonus specifically for the VP to purchase a permanent life insurance policy. Assume a 21% corporate tax rate and a 40% combined marginal tax rate for the VP.

Single bonus scenario:

The VP receives $500,000, which is deposited into a permanent life insurance policy as the annual premium
The corporation deducts $500,000 as employee compensation: tax saving = $500,000 × 21% = $105,000; net cost to corporation = $395,000
The VP reports $500,000 as W-2 income; tax owed = $500,000 × 40% = $200,000 — paid from other personal funds
The VP's cost basis in the policy = $500,000

Double bonus scenario (grossed-up):

$$\text{Required Gross Bonus} = \frac{$500,000}{1 - 0.40} = \mathbf{$833,333}$$

The corporation pays $833,333 in total bonuses; deduction saves 21% = $175,000; net cost = $658,333
The VP reports $833,333 as income; after 40% tax ($333,333), exactly $500,000 remains to fund the policy
VP out-of-pocket cost: $0

Long-term benefits to the VP:

Cash value grows tax-deferred inside the policy
In retirement, the VP can access cash value via tax-free policy loans
If the VP dies, beneficiaries receive the full death benefit income-tax-free

Critical requirement: The corporation cannot be named as a beneficiary or retain any ownership rights in the policy. If the employer has any interest in the policy, the deduction under § 162 is disallowed. The policy must be truly owned by the executive with no strings attached (unless a restrictive endorsement is used for retention purposes).

FAQ — Executive Benefit Plans

Q: What is the main difference between a group carve-out and an executive bonus plan?
A: In a carve-out, the employer replaces the executive's group term coverage above $50,000 with an individual permanent policy — the goal is primarily to eliminate the imputed income tax problem. In an executive bonus plan, the employer simply pays a bonus that the executive uses to purchase a life insurance policy; it is not tied to replacing group coverage.

Q: Why can't the employer deduct premiums for key person insurance, but can deduct premiums under a Section 162 executive bonus plan?
A: The distinction is who benefits. Under key person insurance, the employer is the beneficiary — so the IRS won't allow a deduction (you'd be deducting costs to pay yourself). Under an executive bonus plan, the executive is the policy owner and the beneficiary is the executive's family. The premium is treated as employee compensation — and compensation is generally deductible.

Q: On the exam, what is the most important thing to know about Section 162 executive bonus plans?
A: Three things: (1) the executive owns the policy; (2) the bonus is taxable income to the executive; and (3) the employer can deduct the bonus as compensation. The death benefit is income-tax-free to the beneficiary.