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Split-Dollar Life Insurance

Updated
Dana George
By: Dana George

Our Insurance Expert

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When a company makes a job offer, it often discusses life insurance options as part of the benefits package. And when it's a high-value employee, the options available often include split-dollar life insurance. Here, we'll tell you what split-dollar life insurance is, how it works, and how it benefits both employer and employee.

What is split-dollar life insurance?

Split-dollar life insurance policies are designed to recruit and retain high-value employees. There are two primary types of split-dollar life insurance agreements. Here, we'll tell you how this type of policy works and how each party benefits from the arrangement.

How does a split-dollar life insurance policy work?

Split-dollar life insurance is not a type of policy. Rather, it's an agreement between an employer and an individual. Here's how it works:

  • A company searches for a high-level employee.
  • Potential candidates want to know that if they die, their beneficiaries will have all the money they need.
  • The company chooses a candidate and makes a job offer. As part of the compensation package, they provide split-dollar life insurance.
  • It's a win-win situation. The company gets the high-level employee they want, and the new employee gets life insurance protection for their family.
  • The company purchases a permanent life insurance policy. That means that the policy will last the employee's entire life, as long as premiums remain up to date.

Who owns a split-dollar life insurance policy?

At first glance, split-dollar life insurance may seem confusing, but it's really not. There's only one thing to remember: Split-dollar life represents an agreement between two parties, and every detail stems from that agreement.

For example, which party owns a split-dollar life insurance policy depends on the type of agreement that was made.

Economic benefit and endorsement agreement

With an economic benefit arrangement, the employer owns the policy and pays the premiums. However, the employer allows the employee to choose the life insurance beneficiaries. If the employee dies, the employer ensures that beneficiaries receive a portion of the policy's face value.

Although the employee does not own the policy, they are responsible for paying income taxes on the benefit received. Depending on how the agreement is written, when the employee leaves the company, the policy may be transferred to them, or they can purchase it.

Collateral assignment and loan regime

When an agreement calls for collateral assignment, the employee owns the policy. The employer treats the funds they pay toward premiums as a loan to the employee. If the employee leaves, the loan may be forgiven or the employee may be expected to repay the money, depending on how the agreement was written. What happens to any cash value that has built up also depends on the initial agreement.

While the employee is taxed on the interest-free portion of the loan, the employer receives a tax deduction.

What are the benefits of a split-dollar plan?

When a company offers its employees term life insurance, it's pretty cut and dried. It purchases a policy for a specific amount and pays the premiums. With a split-dollar plan, the company not only purchases a permanent life policy, but it also tailors an agreement with the employee that will benefit all parties involved. And the benefits associated with a split-dollar plan can be plentiful.

For employees

Split-dollar life insurance is a nice perk for employees. Here are some of the reasons why:

  • It provides a higher death benefit for beneficiaries than might otherwise be affordable.
  • The employee may not have to pay anything toward a valuable life insurance policy. If they do contribute to premiums, it's typically only a portion.
  • Depending on how the agreement is written, an employee may be able to take the life insurance policy with them when they leave.
  • The employee is eligible to receive tax-free income through withdrawals and loans.

For employers

Employers understand that they must compete for top-notch talent. Including split-dollar life insurance in a compensation package benefits the employer in five ways:

  1. It helps an employer recruit and retain top talent.
  2. It allows a company to provide a valuable benefit while taking an income tax deduction.
  3. There are fewer limits and rules on split-dollar life insurance plans than with traditional qualified plans.
  4. Split-dollar plans come with lower administrative costs than traditional employee-sponsored life insurance plans.
  5. It allows the company to recoup its investment.

How does split-dollar life insurance work for estate planning?

While split-dollar life insurance has historically been an agreement between an employer and employee, it can also be used for estate planning. An intergenerational split-dollar plan involves an irrevocable life insurance trust (ILIT) "owning" a life insurance policy on a specific member of a family. Premiums are (at least partially) paid by the trust, and proceeds are divided based on how the agreement is written.

Using a split-dollar insurance policy as part of estate planning is intended to reduce the amount of estate taxes due following the death of the insured.

Terminating a split-dollar plan

How a split-dollar insurance plan is terminated depends on how the original agreement is written. Typically, it ends when an employee dies, retires, or leaves the company. As long as it's part of the original agreement, the employee may be able to take their permanent life insurance plan with them. For someone who prefers permanent life to term life insurance, split-dollar life insurance is a valuable perk.

FAQs

  • The employer pays the premiums for both types of plans: Economic benefit arrangement and collateral assignment. The difference is, when the two parties agree on a collateral assignment plan, the employer treats the premiums paid toward the policy as a loan to the employee.

  • Because the employer either pays the premiums directly or through a loan arrangement with the employee, the employee receives an economic benefit. The value of that benefit is taxed as income.

  • Yes, a split-dollar life insurance arrangement is a fringe benefit, typically offered to high-value employees. While it's designed to attract top-notch employees, a split-dollar life insurance policy also benefits the company in the event of the employee's death.

  • A reverse split-dollar policy is owned by the employee, but the employer pays the costs. Typically, the company names itself as the beneficiary, and the two parties agree that the company will receive a specific amount of money if the employee dies. The employee names their own beneficiary who receives what's left of the death benefit once the company claims their portion.

  • The two basic types of split-dollar plans are: An economic benefit split-dollar arrangement, in which the employer owns the policy, and a collateral split-dollar assignment, in which the employee owns the policy.

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