Setting up a Section 162 executive bonus plan is more straightforward than people expect, but it involves a specific sequence of decisions and documentation that’s easy to get out of order. Here’s what the process actually looks like from start to finish, so you know what to expect before your first conversation with a provider.

Step 1: Clarify the Business Goal

Before anything else, get specific about why you’re considering a section 162 bonus plan in the first place. Retaining a specific key employee, rewarding top performers, or building a more competitive executive benefits package all lead to slightly different plan designs. A retention-focused plan, for example, usually includes a vesting restriction, while a pure reward-based plan typically doesn’t.

Step 2: Identify Who Will Participate

Because Section 162 plans aren’t subject to the nondiscrimination testing that applies to qualified retirement plans, the business has complete discretion over who’s included. Decide whether this is for one executive, a small leadership team, or a broader group of highly compensated employees. This decision drives both the total cost of the plan and how much administrative complexity you’re taking on.

Step 3: Determine the Funding Level and Bonus Structure

Work with your provider to determine a realistic annual bonus amount based on the desired policy death benefit and the executive’s age and health. At this stage, you’ll also decide between a single bonus, which covers just the insurance premium, and a double bonus, which adds an additional amount to help offset the income tax the employee will owe on the bonus itself.

Step 4: Choose the Policy Type and Carrier

Your provider should walk you through the tradeoffs between whole life, universal life, and indexed universal life insurance for the specific executive being covered, along with a comparison of carriers. This decision should be based on the executive’s age, health, and the funding timeline — a 40-year-old executive and a 58-year-old executive often end up with different policy recommendations even at similar funding levels.

Step 5: Decide Whether to Restrict the Benefit

If retention is a primary goal, consider adding a restrictive endorsement to the policy — known as a Restricted Executive Bonus Arrangement, or REBA. This limits the employee’s access to the policy’s cash value until a specified vesting condition is met, such as remaining employed for a set number of years. Without a restriction, the employee owns the policy outright from day one and could theoretically access cash value or leave the company without any clawback.

Step 6: Draft the Bonus Agreement

This is the document that formalizes the arrangement — specifying the bonus amount, how and when it will be paid, and any restrictions tied to it. This should be drafted with input from an attorney or your provider’s plan design team and reviewed by your CPA. Skipping this step is one of the most common mistakes business owners make, since an informal handshake arrangement doesn’t hold up well if the plan is ever questioned.

Step 7: Obtain Board or Ownership Approval

Even in a small, closely held business, it’s worth documenting that the bonus plan was a deliberate business decision — through board meeting minutes, a written resolution, or an ownership consent, depending on your entity structure. This creates a clear record that supports the bonus’s deductibility as reasonable compensation.

Step 8: Complete Underwriting

The executive completes a life insurance application, which typically includes health questions and, depending on age and coverage amount, a medical exam. Underwriting timelines vary but generally take two to six weeks. The final premium is confirmed once underwriting is complete, at which point the bonus amount can be finalized if it wasn’t locked in earlier.

Step 9: Set Up the Bonus Through Payroll

Once the policy is approved, the business sets up the bonus as a recurring payroll item, typically timed to coincide with the policy’s premium due date. The bonus is reported as taxable income on the employee’s W-2, and the business takes the corresponding deduction on its return.

Step 10: Confirm the Policy Is In Force and Schedule the First Review

Once the first premium is paid, the policy is in force and the plan is active. From here, the main ongoing task is periodic review — checking in every two to three years to confirm the policy is performing as expected and that the plan still fits the business’s and the executive’s current situation.

Most businesses can move from an initial conversation to an active section 162 executive life insurance plan within four to eight weeks, with underwriting typically being the longest step in the process.

Frequently Asked Questions

How long does it take to set up a Section 162 plan from start to finish?

Most plans are up and running within four to eight weeks, with underwriting on the life insurance policy usually being the longest single step in the process.

Do I need an attorney to set up a Section 162 plan?

It’s not strictly required, but having an attorney review or draft the bonus agreement, especially if you’re including a restrictive endorsement, is strongly recommended to make sure the arrangement is properly documented.

Can I set up a plan for just one employee?

Yes. Because Section 162 plans aren’t subject to nondiscrimination testing, the business can choose to include just one key employee if that fits the goal.

What information does the insurance carrier need from the executive?

Typically a completed application with health history, and depending on age and coverage amount, a medical exam and possibly lab work or an attending physician statement.

Who owns the life insurance policy in a Section 162 plan?

The employee owns the policy, which is what allows the business’s payment toward the premium to be treated as a bonus rather than a business-owned asset.

Can the plan be set up mid-year rather than at the start of a fiscal year?

Yes, there’s no requirement to align the plan with your fiscal year. Plans are commonly set up whenever the business decides to move forward, though aligning the bonus timing with premium due dates simplifies payroll administration.