By Peter Mastrantuono
Split dollar life insurance plans are an affordable but complex solution that helps employers reward key employees with a benefit that provides their families financial protection and supplements future retirement income.
What is a Split Dollar Life Insurance Plan?
A split dollar life insurance plan is a contract between two parties, typically an employer and a key executive. This contract articulates how a life insurance policy will be structured between them, including addressing each party’s responsibilities for premium payment, designating the policy owner and insured and detailing the relative share of the policy’s cash value and death benefits.
There are two basic ways in which split dollar life insurance can be designed:
- Endorsement/economic benefit regime—Under this approach, the employer is the life insurance policy owner and the employee is the insured. The company pays the full premium and owns all of the policy’s cash value, with the death benefit split between the business and the insured’s named beneficiary(ies).
The business may endorse the policy’s cash value in excess of its premium payments to the employee. The death benefit is also divided so that the employer receives a share of the death benefit equal to its cumulative premium payments, with the remaining death benefit going to the employee’s beneficiary(ies).
The employee will be subject to income tax annually on the economic value of the death benefit portion of the premium payment made by the employer.
2. Collateral assignment/loan regime—With this method, the employee owns the policy and is also the insured, with the employer lending the employee (usually interest free) the premium amount required to pay for the policy. The employee will be taxed on the interest-free value of the loan. Should an employee leave, the loan may be paid back by the employee or forgiven by the company, in which case there will be tax consequences to the individual.
The beneficiary is divided between the business, up to the extent of the outstanding loan, and the beneficiary(ies) named by the employee.
Unlike the endorsement method, vesting in the plan does not trigger a taxable event. Once withdrawals begin (e.g., to supplement retirement income) the income is tax-free up to the basis in the life policy.
Benefits of a Split Dollar Life Insurance Plan
There are a number of advantages to both the employer and employee.
For companies, a split dollar life insurance plan can help attract and retain particularly valuable employees without having to satisfy strict ERISA nondiscrimination rules. The plan requires no IRS approval or complicated recordkeeping. Finally, the costs of start-up and administering the plan are quite low.
For key executives, they receive a cost-effective and tax-efficient benefit that bolsters their families’ financial security and may also serve estate planning and retirement income needs. Individuals also benefit from access to cash values via a loan and tax-deferred growth.
Business owners interested in implementing a split dollar life insurance plan should work with their attorney, tax advisor and financial advisor to ensure that the plan is properly structured to meet all relevant legal requirements and satisfy the financial objectives of both the employer and the employee.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.