Executive Bonus Plan in Canada: A Guide for Businesses

Executive bonus plans have emerged as a highly effective talent retention and reward strategy for Canadian organizations. This comprehensive guide examines how executive bonus plans work, benefits, costs, structuring approaches, regulations, and implementation best practices specifically for employers in Canada.

What Are Executive Bonus Plans in Canada?

An executive bonus plan is an employer-sponsored permanent life insurance policy used to incentivize, retain and provide supplemental compensation to valuable C-suite or senior management employees in Canada.

The core elements of executive bonus plans in Canada include:

• The employer pays all premiums for the life insurance policy directly or through a bonus to the executive. This provides a tax-deductible way to provide additional compensation.
• The executive being rewarded is the owner of the life insurance policy and gets to select beneficiaries who will receive the death benefit payout.
• The plan functions as a retention incentive, performance reward, and extra benefit for the executive. Access to cash values and policy portability often become available after a set retention period.
• Executive bonus plans refer to section 162 of the Canadian Income Tax Act, which allows companies to deduct reasonable compensation expenses like bonus arrangements. Therefore, they are sometimes called Section 162 executive plans in Canada.

Executive bonus plans represent a highly flexible approach for Canadian businesses to structure supplemental benefits, retirement income, family protection and incentive arrangements for valued executives.

Key Benefits of Executive Bonus Plans in Canada

Well-designed executive bonus life insurance plans offer significant advantages for both employers and employees:

Benefits to Canadian Employers

• Tax deductions – Premiums are considered reasonable compensation and, therefore, tax-deductible business expenses under section 162 of the Income Tax Act if structured properly. This provides a cost-efficient supplemental compensation strategy.
• Retention incentives – Executive bonus plans help retain key executives who might otherwise leave for better opportunities. The life insurance benefits and deferred access to cash value provide “golden handcuffs.”
• Rewards performance – High-performing executives can be rewarded through prestigious benefits plans.
• Flexible arrangements – Employers can place limits on accessing cash values in early years to align with retention periods. Benefits can be structured around business continuity needs.
• Tax-deferred growth – The cash value within the life insurance policies grows tax-deferred, maximizing the asset value.

Benefits to Canadian Employees

• Supplemental compensation – The premiums paid by the employer equate to supplemental monetary compensation beyond just salary.
• Retirement income – Executives can take loans or withdrawals from the accumulated cash value on a tax-preferred basis to supplement retirement income.
• Family protection – Death benefit payouts pass tax-free to named beneficiaries, protecting the executive’s family.
• Unlimited benefits – Executive bonus plans are not limited by maximum contribution amounts like Registered Pension Plans (RPPs) and Registered Retirement Savings Plans (RRSPs).
• Critical illness/disability access – Policy riders allow executives to access living benefits if disabled or diagnosed with a critical illness.
• Portability – Benefits and policy cash value ownership stay with the executive even if they eventually leave the company.

In summary, appropriately constructed executive bonus plans are a win-win arrangement providing tax, retention, reward, compensation and retirement advantages to employers and executives.

How Executive Bonus Plans Work in Canada

The typical structure and process for executive bonus plans in Canada includes:

• The employer takes out a permanent cash value life insurance policy on a key executive they want to retain and reward. Whole life insurance and universal life insurance policies are most commonly utilized, given their permanent death benefits and tax-preferred cash value accumulation.
• On an ongoing basis, the employer pays all life insurance premiums annually, often structured as a bonus to the executive. Premiums are generally tax-deductible to the company.
• The executive is listed as the owner of the life insurance policy. They can name beneficiaries of their choosing to receive the income-tax-free death benefit payout when they pass away.
• Early access to cash values can be restricted by the employer for a set number of years or tied to a vesting schedule to incentivize the executive to remain with the company.
• Once retired, the executive can access the policy’s cash value through withdrawals, policy loans, or other options provided by the insurance company. This allows them to supplement retirement income in a tax-advantaged manner.

Two popular types of bonus arrangements used to fund executive bonus plans in Canada are:

In either case, the bonuses essentially transfer the cost obligation to the company in a tax-efficient manner.

What Do Executive Bonus Plans Cost in Canada?

The annual premium costs for executive bonus life insurance plans in Canada can vary substantially based on several factors:

• Age and health of the executive – Premiums are higher for older executives in poorer health. Younger, healthy executives can have significantly lower premiums.
• Coverage amount and death benefit – Larger death benefits to protect families have higher premiums. $1 million policies often range between $10,000 – $25,000 annually. $5 million+ policies can be $100,000+.
• Type of life insurance product used – Whole life, universal life, and indexed policies all have different premium levels. Investment options also play a role.
• Insurer underwriting process – Individual underwriting can increase premiums substantially versus simplified underwriting or guaranteed issue products. Employers can negotiate group pricing discounts.

According to the Conference Board of Canada, average executive bonus plan annual premiums range between:

• $10,000 – $50,000 for a $1 million death benefit
• $50,000 – $100,000+ for $2 – $5 million death benefits

As a general guideline, employers can potentially budget approximately 1-3% of the desired coverage amount for the annual premium costs of an executive bonus life insurance plan.

Tips for Setting Up Executive Bonus Plans in Canada

When establishing executive bonus plans in Canada, the following best practices are recommended:

Consult specialized advisors

Executive bonus plans have complex tax, legal, accounting and insurance elements. Work with advisors like:

• Tax experts – To advise on tax deductibility of premiums and structure arrangements to maximize deductions.
• Lawyers – To review compliance issues and draft the required legal agreements between the employer and executives.
• Insurance brokers – To solicit quotes, select optimal products, negotiate pricing and implement plans.
• Accountants – To conduct reasonableness tests on compensation and structure bonus payments.

Thoroughly assess finances and reasonable comp limits

Conduct financial analysis to assess budgeting capacity for premiums based on business performance. Review tax code limits on deducting reasonable compensation over $500k per employee when determining plan size.

Outline vesting schedules

Clearly define time-based vesting schedules at which point executives can access cash values without repayment. This aligns the benefits with retention periods.

Select appropriate products

Evaluate permanent products like whole life, universal life and indexed life to select features optimal for supplementing retirement income.

Coordinate with other executive benefits

Integrate executive bonus plans with other benefits like Deferred Profit Sharing Plans and executive pensions to optimize total rewards.

Analyze cost efficiency regularly

Review investment returns within policies, mortality costs and other pricing factors annually to ensure premium efficiency and adjust plans as needed.

Following structured best practices allows Canadian businesses to optimize the design and maintain the performance of executive bonus life insurance arrangements.

Where To Get Executive Bonus Plan Insurance in Canada

There are several options for Canadian companies to purchase executive bonus life insurance policies:

Major insurance carriers

Most large Canadian insurance companies offer executive bonus life insurance for businesses, including:

• Sun Life Financial
• Manulife
• RBC Insurance
• Canada Life
• iA Financial Group
• Equitable Life

They have national broker networks and can negotiate group pricing.

Independent brokers and MGAs

Specialized life insurance brokers and Managing General Agencies (MGAs) offer deep product expertise and can provide quotes across multiple carriers for the most favourable pricing.

Online marketplaces

Comparison sites like Lifebuzz.ca allow employers to get quotes and apply online for executive bonus plans.

Regardless of channel, working with advisors experienced in executive plans ensures optimal policy design and compliance.

Pitfalls to Avoid With Executive Bonus Plans in Canada

When implementing executive bonus plans, Canadian businesses should beware of these common pitfalls:

• Exceeding reasonable compensation limits – Tax deductions may not apply to premiums if executive compensation is deemed excessive per tax code section 67.
• Overlooking tax implications – Failure to structure plans properly can jeopardize deductibility. Also, we need to consider tax impacts on employees.
• No reviews of plan performance – Should analyze investment returns, mortality costs and other factors annually to ensure efficiencies.
• No post-retirement provisions – Plans should clearly define access to cash values and continuation options when executives retire.
• Poor plan integration – Need to coordinate executive bonus plans with other benefits to create optimal total compensation.
• Lacking clear vesting rules – Cash value access restrictions and schedules should be defined upfront in legal agreements to support retention periods.

Avoiding these missteps allows Canadian employers to realize the full benefits of executive bonus plans.

Key Considerations for Structuring Executive Bonus Plans in Canada

Some additional items to consider when structuring executive bonus life insurance plans in Canada include:

• Type of life insurance product – The main options are whole life, universal life, and indexed universal life, each with different cost structures.
• Coverage amount – Need to balance desired death benefits to protect families with premium budget constraints.
• Premium structure – Single vs. double bonus arrangements, payment frequency, growth strategy.
• Policy ownership and beneficiary details – Plan documents should outline details on ownership and beneficiary designation rights.
• Vesting schedule – Defining the timeline at which deferred benefits and cash value access are unlocked for the executive. This can be tied to years of service, age milestones or other retention factors.
• Portability – Defining whether benefits can remain with the executive if they eventually leave the company.

Optimizing these structural factors allows employers to align executive bonus plans with their business goals and retention needs.

The Bottom Line on Executive Bonus Plans in Canada

Executive bonus plans enable Canadian businesses to attract, retain and reward key management team members through optimized life insurance arrangements.

These plans provide compelling benefits to both employers and executives when thoughtfully structured:

For Employers:

• Tax deductions on premiums
• Incentives to retain top talent
• Rewards for performance
• Tax-deferred cash value growth

For Executives:

• Supplementary compensation
• Retirement income supplements
• Family protection through death benefits
• Critical illness and disability access, if needed
• Benefits not limited by registered plan caps

However, employers need specialized guidance from advisors to avoid missteps related to taxation, accounting, legal compliance, appropriate product selection, and vesting definitions when designing executive bonus plans.

Frequently Asked Questions (FAQs)

Article Sources:

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1. Life Insurance For Executives – https://www.bflcanada.ca/
2. How an executive bonus plan is a win-win for employers & key employees – https://blog.fglife.com/
3. Executive Bonus Plans – https://www.nfp.com/
4. Executive Bonus Life Insurance: What it is and How it works – https://www.globalfd.com/