Deferred Compensation plans are quite popular and have been around for decades. They allow for business owners or executives to receive additional compensation over and above their traditional compensation in a tax favored manner. And one of the simplest forms of these types of plans is a Section 162 Bonus Plan.
A 162 Plan is a bonus paid either to an owner or employee who in turn invests these funds. The bonus is deductible to the company since the bonus is treated as wages and, subsequently, taxable to the employee. Because of this, often times the company will “gross up” the Bonus so that the net amount to the employee is the amount of the desired bonus.
One of the reasons these plans are so popular is in part because of their simplicity, but also because these plans are generally not subject to the governing rules of ERISA. So what does this mean? Unlike a 401(k) or qualified plan, a Bonus Plan can include or exclude anyone in or out of the Plan. In fact, the Plan could be just for the owner himself. This is often music to a business owner’s ears.
There are choices of where this bonus could then be invested: it could be taxable investments, annuities or life insurance. Each of these asset classes has its own inherent tax advantages and disadvantages. The following table breaks these down.