DISADVANTAGES OF EXECUTIVE BONUS PLANS
Full and fair disclosure is an important aspect of suitability. In practical terms, this means that the financial professional is expected to make a balanced presentation to the prospect of both the advantages and disadvantages of any recommendation. While the executive bonus plan has many advantages for both the executive and the employer, there are certain disadvantages that need to be acknowledged.
For the executive, the only significant disadvantage is the required current recognition of income. Although the income tax liability on the growth realized in the cash value is deferred, the executive is required to recognize current income equal to the bonused premium payment each year.
The disadvantages for employers are considered more significant. An important disadvantage is the loss of control over the life insurance policy and its values. Since the executive is the policyowner, the employer's control is limited to the premium payment.
The employer may reduce the current bonus-or pay no bonus at all-but the life insurance policy and its values, paid for by previous bonuses, are entirely under the control of the executive. Accordingly, as a vehicle to retain executives, an executive bonus plan offers only the carrot of possible future contributions without the stick of benefit loss in the event of termination.
A second employer disadvantage of executive bonus plans is their inability to provide for employer cost recovery. As we will examine in our discussion of split-dollar and deferred compensation, the possibility of employer cost recovery makes these plans particularly attractive in the proper situations. Unfortunately, employer cost recovery is not a feature of executive bonus plans.
The final employer disadvantage of executive bonus plans relates to its general tax inappropriateness for sole proprietors or owners of S corporations. Since in both of these organizations there is no distinction between the owners' income tax bracket and the income tax bracket of the employer-both organizations being tax conduits-there is no tax benefit arising from the difference in tax brackets. Executive bonus plans may be used in both of these organizations for non-owners, however. A sole proprietor may derive all of the advantages of any employer offering an executive bonus plan to its non-owner executives.