Executive Compensation

What is Executive Compensation

Executive compensation is a strategy businesses use to attract, retain, and motivate key leaders by offering incentives beyond salary. These plans often include performance-based rewards and long-term benefits that encourage executives to stay and grow with the company.

Common executive compensation strategies may include non-qualified deferred compensation, executive bonus plans, and split-dollar life insurance—approaches that can provide current and future benefits in exchange for continued service over a set period of time.

Nonqualified Deferred Compensation Plan

A nonqualified deferred compensation plan (NQDC) is an arrangement between an employer and a key employee in which the employer agrees to provide additional compensation in the future in exchange for the employee’s continued service for a specified period of time.

How an NQDC Plan Works

The employer and employee agree on the amount of compensation to be deferred and the period of continued service required. When structured to meet applicable tax requirements, the plan may allow an employer to reward selected highly compensated employees for their contributions and encourage long-term retention.

Funded vs. Unfunded

Funded plans may involve setting aside assets to support the promise of future benefits.
If structured as funded, the employee generally must remain subject to a meaningful risk of forfeiture to help avoid current taxation.
Unfunded plans are typically designed so that taxation of deferred compensation occurs when the employee actually receives the benefits.

Informal Funding With Life Insurance

Many NQDC arrangements are informally funded using life insurance owned by the employer on the life of the employee. The accumulated cash value may help support the planned benefit payments over a specified period of time. If the employee dies prior to distribution, the death benefit may be available to support the employee’s family, and the employer may also use proceeds to help offset plan costs (depending on plan design and policy terms).

How distributions are typically taxed

Benefit distributions are generally taxable to the employee when received, and the employer may receive a tax deduction as benefits are paid, subject to applicable tax rules and plan structure.

Executive Bonus Plan

An Executive Bonus Plan (often referenced under IRC Sec. 162) is one way an employer may reward selected key employees by providing a bonus that can be used to pay premiums for a life insurance policy owned by the employee.

How an Executive Bonus Plan Works

The employer bonuses an amount that is commonly intended to cover the net premium payment for a life insurance policy owned by the employee. Because the employee owns the policy, the policy and any cash values generally belong to the employee, who may be able to continue the coverage independently if they leave the employer.

Tax Treatment Basics

The bonus is generally considered additional compensation and is typically taxable to the employee when received.
In some cases, an employer may bonus an additional amount intended to help offset the employee’s tax liability.
Bonuses are generally tax-deductible to the employer, subject to applicable tax rules.

Key Considerations

Executive compensation strategies can involve legal, tax, and insurance considerations. The guidance of qualified professionals is strongly recommended before implementing any plan.

Helpful reminder

Tax rules and plan design details can vary based on the employer, the employee, and the policy structure.

Split Dollar Life Insurance

Split dollar life insurance is a strategy where two parties—often an employer and a key employee—share the costs and benefits of a life insurance policy under a written agreement. The agreement outlines how premiums, cash value access, and death benefits are allocated.

How a Split Dollar Plan Works

A split dollar arrangement is documented through a written agreement that outlines how premium payments are handled and how policy benefits are shared between the parties. The agreement typically specifies what happens at retirement, termination, or other triggering events.

Common Structures

Endorsement-style: the employer typically owns the policy and provides defined benefits to the employee.
Collateral assignment-style: the employee typically owns the policy and assigns certain rights to the employer as collateral.
The structure impacts how costs, values, and benefits are allocated and how tax rules may apply.

Key Considerations

Split dollar arrangements can be complex and involve legal, tax, and insurance considerations. Proper documentation, administration, and coordination with qualified professionals is strongly recommended.

Documentation matters

A written agreement typically defines how premiums are paid, how benefits are shared, and how the arrangement ends.

¹ Nonqualified deferred compensation arrangements may be funded, unfunded, or informally funded with the use of a life insurance policy.

² Please consult a tax professional regarding your specific situation.

Executive compensation FAQs

What is executive compensation planning?

Executive compensation planning involves designing incentive and benefit strategies to help businesses attract, reward, and retain key executives.

Are executive compensation plans appropriate for every business?

Not necessarily. These strategies depend on business size, cash flow, goals, and regulatory considerations.

Do executive compensation plans involve tax or legal considerations?

Yes. These plans often involve complex tax, legal, and insurance issues and typically require coordination with qualified professionals.

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