A Comprehensive Guide to What Is a Split Dollar Life Insurance Policy

A split dollar life insurance policy is a type of life insurance arrangement that allows multiple parties to share the premiums and benefits of a single life insurance policy.

This arrangement is often used by employers to provide supplemental retirement income to key employees, or by business partners to share the cost of life insurance coverage.

The policyholder typically pays a portion of the premium, while the other party, usually an employer or business partner, pays the remaining premium.

In return for their share of the premium, the policyholder receives a portion of the policy's death benefit, usually in the form of a tax-free distribution.

Split-dollar life insurance policies offer several benefits, including extra compensation for key employees, tax savings, and improved retention for employers.

Employees can receive a substantial life insurance policy paid for by their employer through a split-dollar agreement, which can provide them with extra money in retirement.

Split-dollar agreements generally do not have the same restrictions and contribution limits as workplace retirement plans, such as a 401(k), allowing employers to give more money to executives and key employees.

Tax savings are another benefit of split-dollar policies, as the cash value grows tax-deferred, similar to a 401(k) or retirement account.

Employers can use split-dollar agreements to attract and retain highly skilled employees by offering more compensation beyond standard retirement plans.

If the covered employee dies, the employer and the employee's heirs receive a payout, as laid out by the agreement, providing benefits for both parties.

Here are some key benefits of split-dollar life insurance:

Split-dollar policies can also be used for estate planning, providing estate liquidity while minimizing gift taxes and the use of an individual's lifetime exemption.

In addition, split-dollar policies can be beneficial for business buy-sell planning, allowing companies to provide key-person protection on an employee or owner.

By understanding the benefits and considerations of split-dollar life insurance policies, individuals and businesses can make informed decisions about whether this type of policy is right for them.

Split-dollar life insurance policies can be structured in various ways, each with its own set of rules and tax implications. There are different types of agreements, and understanding them can help you make informed decisions about your policy.

One type of agreement is the endorsement agreement, where the employer owns the life insurance policy and signs an endorsement agreement pledging to give the employee's beneficiaries their share of the death benefit.

In a collateral assignment agreement, the employee doesn't owe income tax for the annual premium payments, but they do have to pay interest on the loan balance at a market rate determined by the IRS.

The employee can pay off the loan at the end of the agreement, or the employer can waive it. If the employee pays off the loan, they won't owe taxes. If the employer forgives the loan, the employee must declare the forgiven balance as taxable income.

Here are the different types of split-dollar agreements, depending on who owns the life insurance policy:

In a loan regime, the employer pays the premiums, and the employee is supposed to pay back the loan at the end of the agreement. If the employer forgives the loan, the employee must declare the forgiven balance as taxable income.

A split-dollar life insurance policy is a type of agreement that combines the benefits of permanent life insurance with a tax-efficient way to share the costs.

To start, you'll need to purchase a permanent life insurance policy, typically whole life insurance, which provides a guaranteed benefit and coverage that lasts a lifetime as long as premiums are paid when due.

The policy's premiums will never change, and it also provides a cash value that can be accessed while the insured is still alive.

A company can purchase a permanent life insurance policy on the life of an executive and pay all premiums, then endorse a portion of the death benefit to the executive as a pre-retirement survivor benefit.

This arrangement is often used in business settings to incentivize key employees to stay with the company.

In a split-dollar life insurance agreement, the life insurance policy itself and its benefits do not change with the addition of the agreement.

The additional contract outlines how different aspects will be divided and how taxes will be applied to the policy.

Here's a breakdown of how a split-dollar life insurance policy can be structured:

For example, a business owner might offer a top salesperson a $2-million split-dollar whole life insurance policy using an endorsement agreement lasting 10 years.

A split-dollar life insurance policy can be a complex arrangement, and understanding the tax implications is crucial. The taxation of a split-dollar plan largely depends on who owns the policy. If the employee owns the policy, any premiums paid by the employer are considered a loan, and the employee must pay interest on this loan.

In an endorsement agreement, where the employer owns the policy, the premium payments count as taxable income for the employee based on the value of the life insurance. This means the employee must pay taxes on the value of their portion of the death benefit, insurance coverage, and any accrued cash value.

The Internal Revenue Service (IRS) has specific rules governing the taxation of split-dollar plans, ensuring that both parties understand their tax obligations. These rules are designed to prevent tax avoidance and ensure that the economic benefits of the policy are appropriately taxed.

Here are some key tax implications to consider:

It's essential to understand that the tax implications of a split-dollar plan can be complex and depend on the specific arrangement. It's recommended to consult with a tax professional to ensure compliance with IRS regulations and to minimize tax liabilities.

A split-dollar life insurance plan can be terminated under several circumstances, such as the employee leaving the company, reaching a specified termination date in the agreement, or the employee’s death.

If the employee leaves the company, the employer can terminate the plan, and the employee may be able to access tax-efficient income after plan termination through withdrawals or loans.

The employer receives a portion of the death benefit at least equal to their outlay when the employee dies, while the remaining balance is paid to the employee’s beneficiaries.

This arrangement allows employers to recover plan costs when the agreement ends, making it a mutually beneficial arrangement for both parties.

Business owners who want to protect their company from potential losses if a high-value employee passes away should consider a split-dollar life insurance policy. This type of policy was historically used to cover the potential losses a company could incur if its CEO or another very important employee passed unexpectedly.

If you're a business owner, you might want to consider offering split-dollar life insurance as an attractive benefit to lure high-value employees. Benefits packages for top employees are very competitive, and company-paid split-dollar life insurance can still help a company compete for top talent.

Business owners who want to reward and retain key employees might also want to consider a split-dollar life insurance policy. It's a way to give a few essential contributors extra compensation beyond standard retirement plans, such as a 401(k).

Someone with a sizable net worth concerned about owing estate taxes could use a private split-dollar policy to help minimize the tax hit. This strategy can leave more money for heirs, which is a great benefit for those who think they might owe estate taxes one day.

A business owner who wants to provide an attractive benefit to lure high-value employees might consider offering a split-dollar whole life insurance policy, like Camila did with Elijah. She offered him a $2-million split-dollar whole life insurance policy using an endorsement agreement lasting 10 years.

Split-dollar life insurance arrangements have existed since 1964, providing a way for employers to fund a majority of the premium payments while employees can access the cash value and name their own beneficiary.

The IRS viewed the gain in cash value as escaping taxation and potentially abusive, leading to a series of Revenue Rulings that required employees to pay a tax on the value of the death benefit.

In 1964, split-dollar life insurance arrangements began, with employers typically funding the majority of the premium payments, and employees accessing the cash value and naming their own beneficiary.

The IRS used the one-year term premium of the face amount or an IRS published table (PS 58) to indicate the value of the policy each year, as stated in the Revenue Rulings.

In 2001, the IRS published Notice 2001-10 and 2002-8 to address the taxable amounts of split-dollar life insurance policies, and the Treasury implemented regulations similar to the IRS notices in September 2003.

Split-dollar life insurance policies can be structured in various ways, and one of the most popular arrangements is the economic benefit regime. Under this regime, the employer or individual advances premiums and assigns certain rights to the employee or Irrevocable Life Insurance Trust (ILIT).

The value of the economic benefit is based on IRS-issued Table 2001 rates or the insurer's annual renewable term rates, whichever is lower. This value increases with age.

There are four primary designs that can be utilized under the economic benefit regime: Private Non-Equity Collateral Assignment between a Family Member(s) and Trust, Corporate Non-Equity Collateral Assignment between a Company and Employee or Trust, Endorsement Split Dollar where the Company Owns the Policy and Provides Benefits to the Employee, and Private Switch Dollar.

Here are the four primary designs of the economic benefit regime:

These designs can help employers and employees achieve specific planning objectives, such as reducing tax liabilities and increasing benefits.

Split-dollar life insurance is a valuable tool for companies and families alike, offering a range of benefits that can be tailored to individual needs.

Companies can use split-dollar life insurance to provide additional benefits to key employees, which can be a great way to attract and retain top talent.

Families can also use split-dollar life insurance to minimize gift taxes and estate taxes, giving them more control over their financial legacy.

Your specific situation, including your age and financial goals, will ultimately determine the best split-dollar arrangement for you.

Working with an experienced attorney and life insurance advisor is crucial to navigating the complexities of split-dollar life insurance, so don't be afraid to seek professional guidance.