Under an executive bonus arrangement, the employer pays a bonus each year to selected employees, typically either in cash or in the form of premiums on life insurance or disability policies on their lives. This is not the same as key employee insurance, which is intended to protect the business from losses resulting from the employee’s death. Rather, it is employer-financed personal life and disability insurance intended to benefit the selected employee.
The employee usually applies for and owns the policy, naming someone other than the employer as beneficiary. The cash bonus or premium is declared as additional compensation on the employee’s W-2. The annual taxes on this bonus are, in some cases, funded by an additional cash bonus to the employee. Eventually, the policy’s annual cash value increase will exceed the tax on the bonus and may be borrowed or withdrawn to pay taxes. Policy loans or withdrawals will, of course, reduce the death benefit and may have tax consequences.