The short answer: A business bonusing itself money to buy a policy (Section 162) and a business redirecting old retirement money to buy a policy (the pretax route) get lumped together in search, but they're opposite mechanisms — new money taxed now versus old money still deferred. There's also a third option almost nobody names: build the policy inside your own plan's new contributions, starting with term while that money is young and converting to whole life once it's seasoned enough to escape the percentage caps entirely.
Two business owners searched almost the same phrase this week. One typed "section 162 executive bonus life insurance." The other typed "pretax life insurance business owner." They think they're comparing options. They're actually describing two different mechanisms — and there's a third one sitting between them that most comparisons skip entirely.
Dana owns a nine-person marketing agency, three years old, structured as an S-corp. She wants a $750,000 permanent policy — partly for her family, partly because a buy-sell agreement with her business partner will need funding eventually. She already has a Solo 401(k). What she doesn't have is an old 401(k) or IRA sitting at a former employer, because she went straight from agency work into running her own shop. That single fact rules out one of the two paths people usually compare — and opens up the third.
This article walks through all three: which one actually fits a given business, and why the "aha" for a lot of owners isn't Section 162 or the rollover route at all.
Series · Buying Life Insurance With Pretax Retirement Plan Dollars
This is one article in a series on the legitimate ways business owners fund permanent life insurance with pretax and rollover retirement money.
Hub Pretax Life Insurance Strategies for Business Owners →
1 Is a 412(i) Plan a Scam? →
2 Rolling Old 401(k) or IRA Money Into Life Insurance →
3 Section 162 vs. Pretax: Which Funds Your Plan? — You're Reading This
4 How Life Insurance Fits Inside a Cash Balance Plan →
5 Getting a Policy Out of a Qualified Plan →
This is one article in a series on the legitimate ways business owners fund permanent life insurance with pretax and rollover retirement money.
Hub Pretax Life Insurance Strategies for Business Owners →
1 Is a 412(i) Plan a Scam? →
2 Rolling Old 401(k) or IRA Money Into Life Insurance →
3 Section 162 vs. Pretax: Which Funds Your Plan? — You're Reading This
4 How Life Insurance Fits Inside a Cash Balance Plan →
5 Getting a Policy Out of a Qualified Plan →
Path 1: Section 162 — New Money, Now
Your business pays you a bonus. The bonus is deductible to the business and taxable to you. You take that after-tax money and buy a policy you personally own from day one. No plan, no trustee, no waiting — but the tax bill lands the year you fund it, and the business needs fresh cash flow to cover it every year the arrangement runs.This is also the only path here that works for rewarding someone other than yourself. If you're trying to retain a key employee who isn't an owner, Section 162 is your tool — the pretax paths below only ever use a participant's own retirement money. The full mechanics, including the REBA variation that adds a golden-handcuff clause, live in our dedicated Section 162 article.
Path 2: Pretax With Old Retirement Money
If you've got a 401(k) or traditional IRA parked at a former employer, you can roll it into a Solo 401(k) and have the plan buy the policy — no taxable withdrawal, no new cash flow required. This is the fastest of the three paths precisely because rollover money is exempt from the percentage limits that cap new contributions.Dana doesn't have this option — common for owners who built their business straight out of school. If you do have old retirement money sitting around, the full rollover mechanics are covered here.
Path 3: The Bridge Strategy — Term Now, Whole Life Later
This is where Dana lands, and it's the path most comparisons skip because it doesn't fit neatly into "new money" or "old money." It's new money, but inside the plan rather than outside it — and it takes a few years to fully open up.Why it starts with term. The incidental-benefit rule limits how much of a plan's contributions can go toward premium: 50% of contributions for whole life, a tighter 25% for term or universal life. A young account clears the 25% cap on term far more easily than the 50% cap on whole life.
Why the room grows. Contributions that season stop being subject to either cap. Under the two-year rule, each year's contribution ages out individually once it's been in the plan two years. Under the five-year rule, once a participant hits five years in the plan, the entire account — including money contributed that same month — is treated as seasoned. Either way, seasoned money funds insurance with no percentage limit at all.
For Dana: term today, sized to what current contributions support under the 25% cap. As contributions season, that opens room to convert into the whole life policy she actually wants. Here's the shape of it with numbers attached — hypothetical, for illustration only, not a projection of what any real plan or policy would return: Dana's Solo 401(k) holds $60,000 in profit-sharing contributions in year one. Under the 25% cap, that supports roughly $15,000 of term premium — plenty for a $750,000 term policy at her age. By year three, with contributions continuing and the earliest dollars crossing the two-year seasoning mark, a meaningful slice of the account is exempt from the percentage test entirely, opening room to convert into the whole life policy she wants without a new cap standing in the way.
One number to confirm before building a plan around this: a Solo 401(k) contribution blends two buckets — elective deferral and employer profit-sharing. There's a real, unsettled question about whether elective deferrals count toward the seasoned pool at all, or only the profit-sharing portion does. If only profit-sharing counts, the seasoned dollars available may be smaller than your total balance suggests. Confirm the split with your plan's TPA before finalizing premium amounts.
Which Path Fits Your Business?
| Section 162 | Pretax Rollover | Bridge Strategy | |
|---|---|---|---|
| New cash flow needed | Yes, every year | No | Already budgeted contributions |
| Tax timing | Now, on the bonus | Deferred, as before | Deferred, as before |
| Personal ownership | Day one | Requires plan exit later | Requires plan exit later |
| Best fit | Strong cash flow, or rewarding a non-owner key employee | Old rollover money available | No old money, established contributing plan |
A Word on Compliance
Every path here runs through a plan document, and the document has to actually authorize what you're doing before you do it — a generic, off-the-shelf Solo 401(k) document may not. Using plan assets to benefit anyone other than the plan itself, including funneling value back into your own operating business, risks crossing into prohibited-transaction territory under ERISA. Loop in your plan's third-party administrator, and ERISA counsel for anything beyond routine premium funding, before you move money.Frequently Asked Questions
Can I combine Section 162 and the bridge strategy?
Yes. Some owners fund an immediate, smaller Section 162 policy for near-term needs while the bridge strategy builds toward a larger permanent policy inside the plan. They solve different timing problems, not competing ones.Does my business need to be a certain size or age for the bridge strategy?
No minimum size, but it assumes an established plan with a contribution history — a business making its first profit-sharing contribution this year has no seasoned money yet, by definition.What if I've already maxed out my elective deferrals?
That doesn't affect your profit-sharing room, which is calculated separately. It may affect how much of your account counts toward the seasoned pool — see the compliance flag above, and confirm with your TPA.Is this the same as using my 401(k) to fund my business?
No — that's a ROBS, a different strategy entirely built around your plan buying stock in a new C-corp to capitalize the business itself. Every path here funds a life insurance policy, not business operations.For Dana, the answer turned out to be the least obvious of the three — not the bonus she could have paid herself this year, not a rollover she doesn't have, but patience with money she was already contributing anyway. That's usually the pattern with this comparison: the "right" path is less about which one sounds best and more about what your business already has in motion.
You can find my background and how to reach me at my profile page. Provisions here vary by plan document, insurer, and state — treat everything above as the start of that conversation, not the end of it.
Dana is a composite character representing a common client situation, not a real person.