The life insurance policy is the actual mechanism that makes a Section 162 executive bonus plan work — the bonus is just the funding source. If you understand how the policy itself functions, the rest of the strategy becomes much easier to follow. Here’s a closer look at what the executive or key employee is actually receiving, and how the moving parts fit together.

Who Owns the Policy

In the vast majority of section 162 life insurance arrangements, the employee is the policy owner from day one. This is a critical distinction from other business-related insurance strategies, like key person insurance, where the company owns the policy and is also the beneficiary. Because the employee is the owner here, they hold all the standard rights of ownership — naming a beneficiary, applying for policy loans once cash value accumulates, and controlling how the policy is used, subject to any restrictions the business has put in place through a restrictive endorsement.

Who Is the Insured

Typically, the employee is both the owner and the insured under the policy, meaning the death benefit is paid out upon their death. This is different from key person insurance, where the business insures the employee’s life but the death benefit protects the company against the financial loss of losing that person. In a Section 162 plan, the death benefit protects the employee’s own family or estate, which is part of what makes the benefit personally meaningful to the executive receiving it.

Who the Beneficiary Is

Because the employee owns the policy, they choose the beneficiary — typically a spouse, children, or a trust set up for estate planning purposes. This is one of the more personally valuable aspects of the plan from the employee’s perspective: they’re receiving a benefit they control and can direct exactly as they would any personal life insurance policy they purchased and paid for themselves.

How Premiums Are Actually Paid

The business pays the employee a bonus, generally timed to align with the policy’s premium due date. The employee then uses that bonus — now taxable income to them — to pay the premium directly to the insurance carrier. In some arrangements, for administrative simplicity, the premium is paid directly by the business on the employee’s behalf and reported as additional compensation, though the economic effect is the same either way: the value ultimately flows to the employee as taxable compensation.

How Cash Value Builds

Permanent life insurance policies — whole life, universal life, and indexed universal life — allocate a portion of each premium toward the policy’s cash value, which grows over time on a tax-deferred basis. In the earliest years, a larger share of the premium goes toward the cost of insurance and, depending on the policy, surrender charges, so cash value accumulation tends to be modest at first and builds more meaningfully in later years. This cash value is what gives the policy value beyond the death benefit — it’s an asset the employee can potentially access through loans or withdrawals, subject to any restrictions in place.

What Happens With a Restrictive Endorsement

If the business wants to use the plan for retention, it can attach a restrictive endorsement — creating a Restricted Executive Bonus Arrangement, or REBA. This limits the employee’s access to cash value, and sometimes their ability to change the beneficiary or surrender the policy, until they’ve satisfied a vesting condition, typically a set number of years of continued employment. Once vested, the restriction is removed and the employee gains full, unrestricted control of the policy, just as they would in a standard unrestricted plan.

How the Death Benefit Fits Into the Picture

If the insured employee dies while the policy is in force, the death benefit is paid directly to the named beneficiary, generally income tax-free. This is one of the most valued parts of the benefit from the employee’s perspective — it provides real financial protection for their family, funded in large part by the business, on top of whatever cash value the policy had accumulated during their lifetime.

Understanding these mechanics — ownership, premium flow, cash value growth, and how restrictions work — makes it much easier to evaluate whether an executive bonus life insurance plan fits a specific employee’s situation and the business’s broader compensation strategy.

Frequently Asked Questions

Does the employee need to pass a medical exam to get the policy?

Yes, in most cases. Because the employee is the insured and the policy is underwritten like any individually owned life insurance policy, health history and, depending on age and coverage amount, a medical exam are typically required.

Can the employee change insurance carriers later if they’re unhappy with the policy?

Generally yes, through a 1035 exchange, which allows cash value to move to a new policy without immediate taxation, though this involves new underwriting and should be evaluated carefully against surrender charges on the existing policy.

What happens to the cash value if the policy is surrendered?

Surrendering the policy returns any remaining cash value to the owner, minus any surrender charges that may apply, and any amount above the policy’s cost basis is generally taxable as ordinary income.

Can the employee name multiple beneficiaries?

Yes, standard beneficiary designation rules apply, allowing the employee to name multiple primary or contingent beneficiaries and specify how the death benefit should be divided among them.

Is the policy portable if the employee changes jobs?

In an unrestricted plan, yes — the employee keeps the policy regardless of employment status, though they become responsible for premiums going forward. In a restricted plan, this depends on whether the vesting condition was met.

How is the cash value taxed while it’s growing?

Cash value growth inside a permanent life insurance policy is generally tax-deferred, meaning the employee doesn’t pay taxes on the growth each year — taxation typically only comes into play if funds are withdrawn beyond the policy’s cost basis or if the policy lapses with an outstanding loan.