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Understanding Section 162: Maximize Tax Deductions & Retain Key Employees

, | March 14, 2024 | By

Is Section 162 a panacea for tax planning and employee retention? This often-overlooked section of the Internal Revenue Code allows employers to provide life insurance coverage for key employees and executives. Offering a range of benefits for both employers and employees alike, this is a must have tool when considering both corporate tax planning and employee retention. Let's review some key provisions of this seldom utilized structure. 

What is Section 162 Life Insurance?

  • Section 162 life insurance refers to life insurance policies purchased by employers to  cover key employees.

  • Key employees are those individuals whose contributions are critical to the success and stability of the company.

  • These policies are typically owned by the employer and provide death benefits to the employee's beneficiaries.

Tax Considerations:

  • Premium Deductions: Employers can generally deduct the premiums paid for Section 162 life insurance as a business expense, subject to certain limitations and conditions. This benefit can be amplified with a “double-bonus” scenario, where the employer also issues a cash bonus to pay the income tax associated with the insurance premium payment benefit.

  • Tax-Free Death Benefits: The death benefits received by the employee's beneficiaries are generally tax-free, providing a valuable source of financial support without incurring additional tax liabilities. Portability, vesting, and policy value can all be tailored to the individual need.

Employer Benefits:

  • Tax Deductions: Employers can generally deduct the premiums paid for Section 162 life insurance as a business expense, reducing their taxable income.

  • Recruitment and Retention: Offering life insurance coverage under Section 162 can be a powerful recruitment and retention tool. It demonstrates a commitment to employees' well-being and financial security, making the company more attractive to top talent.

  • Succession Planning: In the event of a key employee's unexpected death, the death benefit can provide financial stability to the company, allowing for smoother succession planning and minimizing disruptions to operations.

Employee Benefits:

  • Financial Protection: Key employees often have families or dependents who rely on their income. Section 162 life insurance provides financial protection to their loved ones in the event of their untimely demise.

  • Supplemental Coverage: While many employees may have life insurance coverage through their employer's group policy, Section 162 insurance can offer additional coverage tailored to the individual's needs, potentially providing a higher death benefit.

  • Portability: In some cases, Section 162 policies may offer portability options, allowing employees to retain coverage even if they leave the company, typically by converting the policy to an individual one.

The Fine Print:

  • Coverage Limits: Employers should carefully consider the coverage limits and ensure that they adequately reflect the key employee's value to the organization and their financial needs.

  • Legal and Regulatory Compliance: Employers must comply with relevant legal and regulatory requirements when implementing Section 162 life insurance plans, including nondiscrimination rules and ERISA regulations.

As always, consultation with industry experts is critical. With the complexity of tax and insurance laws, designing and implementing Section 162 life insurance plans requires careful coordination with trusted professionals.

Questions? Talk to our team today.