Written by Rob Massa
Designing meaningful retirement and incentive benefits for senior executives has become more complicated than ever. Income-based limits on tax-advantaged savings, tighter Roth contribution rules taking effect in 2026, and restrictions on using 401(k) or defined benefit plans for creative retention strategies have all made rewarding executives more difficult.
Nonqualified deferred compensation plans remain an option, but they’re often expensive, complex, complicated to administer and the benefits may be forfeitable if the organization undergoes financial difficulties. That’s why more employers are revisiting a simpler tax-efficient alternative: the Section 162 Program.
What Is a Section 162 Program?
A Section 162 Program is a compensation strategy that allows employers to provide valuable long-term benefits to key employees while maintaining tax efficiency.
Named after Section 162 of the Internal Revenue Code, the program allows businesses to deduct “reasonable compensation” as a business expense. Under this arrangement, a company pays the cash compensation to an employee who uses it to purchase a life insurance policy or other financial asset.
The result can be a benefit for both the employer and the employee:
- The company receives a tax deduction for the premiums funded to the program.
- The employee gains both protection and potential long-term wealth accumulation through the policy’s cash value.
Why Employers Like It: Simplicity and Flexibility
Unlike formal nonqualified plans, a Section 162 Program is straightforward to implement and doesn’t require complex plan documentation or IRS filings. There are no contribution limits, no discrimination testing, and minimal administrative burden.
Employers can even add a “double bonus” which acts as an additional payment to cover the employee’s income taxes on the amounts contributed. This results in any compensation funded to the program almost tax-free, with the full intended value being received by the employee without a reduction of their take-home benefits.
Why Executives Appreciate It: Long-Term Financial Growth
For employees, the life insurance policy purchased with the premiums include a cash value component, allowing tax-deferred accumulation over time. This can serve multiple purposes:
- Supplemental retirement income through policy withdrawals or loans
- Estate planning benefits and death protection for family members
- Liquidity during emergencies without triggering early withdrawal penalties
- Policy loans at retirement can allow access to program funds on a tax-free basis, making this program akin to a Roth account.
When compared to a traditional salary increase, which is fully taxable immediately, a Section 162 plan offers a more strategic way to build long-term financial security.
What Should Employers or Employees Should Know Before Deciding to Implement a 162 Program?
It’s important to remember that while a 162 program has many benefits, like any insurance or investment product, these programs do have certain characteristics you should consider before deciding to implement them:
Employer Considerations
- Since the policy is owned by the executive, they can often take the policy (and cash value) with them if they leave, unless you layer on restrictive provisions like a Restricted Executive Benefit Agreement (REBA).
- The bonus paid to fund the policy is tax-deductible to the employer (as long as it’s reasonable compensation), but the employer does not retain any ownership or benefit from the policy.
- While deductible, it’s still an immediate cash outflow for the employer. Other arrangements, such as a split-dollar plan or nonqualified deferred compensation (NQDC) plan, may provide stronger long-term retention benefits for similar cost, unless the employer uses a REBA.
Employee Considerations
- Since this program is funded with life insurance, the policy accumulations are typically lower in the first 3-5 years of the policy due to the risk associated with the mortality of the Primary Insured on the Policy that the insurer assumes. So, it’s important to be reasonably certain that the Policyowner intends to fund policy premiums for at least 5 years.
- The bonus is treated as ordinary income in the year it’s paid. The executive must pay income taxes on both the base bonus and any tax gross-up the employer provides. This can create a cash flow burden if the employer doesn’t gross-up the tax portion.
- The executive owns the life insurance policy and bears the investment and performance risk. Poor policy performance could reduce the long-term value or even cause the policy to lapse; especially in years where policy premiums are not being actively funded.
A Tool for Retention and Recruitment
In a competitive talent market, offering creative, tax-advantaged benefits can make a company stand out. Section 162 Programs give employers a way to link executive rewards with loyalty and performance, while avoiding many of the regulatory headaches of deferred compensation programs.
By tying benefits to tenure or performance milestones through vesting arrangements or restrictive endorsements, companies can align executive retention with long-term goals.
The Bottom Line
A Section 162 Program isn’t just a tax strategy, it’s a flexible, efficient way to reward, retain, and protect your top talent. It blends the advantages of insurance-based planning with simplicity that fits today’s compliance-heavy environment.
If your company is struggling to balance executive retention goals with tax efficiency and administrative simplicity, it may be time to take a fresh look at what a Section 162 Program can offer. If you’re wondering whether a pension risk transfer could work for your organization, reach out to us and let us conduct a study for you.
Advisory products and services offered by Investment Adviser Representatives through Prime Capital Investment Advisors, LLC (“PCIA”), a federally registered investment adviser. PCIA: 6201 College Blvd., Suite#150, Overland Park, KS 66211. PCIA doing business as Prime Capital Financial | Wealth | Retirement | Wellness | Family Office | Tax Advisory.
The post Executive Deferred Compensation Options: Unlocking the Power of a Section 162 Program appeared first on Prime Capital Financial.
