Split-Dollar Life Insurance

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Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on July 04, 2023

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What Is Split-Dollar Life Insurance?

Split-dollar life insurance is a unique arrangement in which two parties, typically an employer and employee, share the costs, benefits, and ownership interests of a permanent life insurance policy.

This type of arrangement can provide an affordable method for employees to obtain life insurance coverage while also serving as a valuable employee retention and reward strategy for employers.

Split-dollar life insurance agreements are typically structured in one of two ways: the endorsement method or the collateral assignment method. These arrangements dictate how premiums, death benefits, and policy cash values are shared between the employer and the employee.

Split-dollar life insurance arrangements offer several benefits to both employers and employees, including cost-sharing, flexibility in policy design, and potential cash value growth.

These arrangements can provide financial security to employees while offering employers an attractive means of retaining and rewarding key personnel.

Types of Split-Dollar Life Insurance Arrangements

Endorsement Method

Employer-Owned Policy

Under the endorsement method, the employer owns the life insurance policy and is responsible for paying the premiums.

The employer designates a portion of the policy's death benefit to be paid to the employee's designated beneficiary, while the remainder goes to the employer or another designated beneficiary.

Allocation of Policy Benefits and Premiums

In this arrangement, the employer and employee agree on the allocation of policy benefits, with the employer typically retaining a portion of the death benefit and any accumulated cash value.

The employee is responsible for paying income tax on the economic benefit associated with their share of the death benefit.

Collateral Assignment Method

Employee-Owned Policy

With the collateral assignment method, the employee owns the life insurance policy and assigns a portion of the death benefit and cash value to the employer as collateral for the employer's premium payments.

Allocation of Policy Benefits and Premiums

In this arrangement, the employer and employee agree on the allocation of policy benefits, with the employer typically recouping their premium payments from the policy's death benefit or cash value.

The employee is responsible for paying income tax on the value of the employer's premium payments.

Key Features of Split-Dollar Life Insurance

Premium Sharing

In a split-dollar arrangement, the employer and employee share the cost of the life insurance premiums. This cost-sharing structure can make life insurance more affordable for employees, especially for those seeking permanent life insurance coverage.

Death Benefit Allocation

The death benefit of a split-dollar life insurance policy is divided between the employer and employee, based on the terms of the agreement. This allocation provides financial protection for both parties and can be customized to meet their respective needs.

Cash Value Accumulation

Permanent life insurance policies, such as whole or universal life, accumulate cash value over time. In a split-dollar arrangement, the cash value growth can be shared between the employer and employee, providing an additional financial benefit to both parties.

Tax Implications

Tax Treatment for Employers

Employers can generally deduct their premium payments for split-dollar life insurance arrangements, subject to certain limitations.

The tax treatment of policy proceeds, such as death benefits and cash values, will depend on the specific structure of the arrangement and the employer's ownership interest in the policy.

Tax Treatment for Employees

Employees may be subject to income tax on the economic benefit associated with their share of the policy's death benefit or the value of the employer's premium payments, depending on the structure of the split-dollar arrangement.

The tax treatment of policy proceeds, such as death benefits and cash values, will also depend on the employee's ownership interest in the policy.

Advantages of Split-dollar Life Insurance

Affordability for Employees

Split-dollar life insurance arrangements can make permanent life insurance coverage more affordable for employees,

Employer Retention and Reward Strategy

Split-dollar life insurance arrangements serve as a valuable tool for employers to retain and reward key employees. By offering shared benefits and cost-sharing arrangements, employers can create a strong incentive for employees to remain with the company and contribute to its success.

Flexibility in Designing Arrangements

Split-dollar life insurance agreements offer flexibility in designing the policy to meet the specific needs of both the employer and employee.

This includes selecting the type of life insurance policy, determining the allocation of premiums and benefits, and adjusting the agreement over time as circumstances change.

Potential for Cash Value Growth

In addition to the death benefit, permanent life insurance policies accumulate cash value over time. Split-dollar life insurance arrangements allow both the employer and employee to benefit from this cash value growth, providing an additional financial incentive for both parties.

Disadvantages of Split-dollar Life Insurance

Complexity of Agreements

Split-dollar life insurance arrangements can be complex and may require the assistance of legal and financial professionals to establish and maintain. The costs associated with drafting and managing the agreement should be weighed against the potential benefits.

Tax Considerations and Compliance

The tax implications of split-dollar life insurance arrangements can be complex, and both employers and employees must carefully consider the tax consequences of the arrangement.

Ensuring compliance with tax regulations may require the assistance of tax professionals and may result in additional costs.

Limited Availability and Eligibility

Split-dollar life insurance arrangements are typically only available to key employees of a company, limiting their availability to a small group of individuals.

Additionally, not all insurance providers offer split-dollar life insurance arrangements, which may limit the options for employers and employees seeking this type of coverage.

Potential for Conflicts of Interest

Split-dollar life insurance arrangements create a financial relationship between the employer and employee, which may lead to potential conflicts of interest. Both parties should carefully consider this relationship and establish clear guidelines to avoid potential issues.

Benefits and Drawbacks of Split-Dollar Life Insurance

When to Consider Split-dollar Life Insurance

Key Factors for Employers

Employers should consider split-dollar life insurance arrangements when they are seeking a cost-effective way to provide life insurance coverage for key employees while also creating a strong retention and reward strategy.

Key Factors for Employees

Employees should consider split-dollar life insurance arrangements when they need life insurance coverage but find the cost of permanent life insurance policies prohibitive.

Additionally, employees should evaluate the potential tax implications and weigh the benefits against any potential drawbacks.

Evaluating Alternative Strategies

Before committing to a split-dollar life insurance arrangement, both employers and employees should evaluate alternative strategies, such as group life insurance plans or supplemental life insurance policies, to determine the most appropriate and cost-effective solution for their needs.

Establishing a Split-dollar Life Insurance Agreement

Selection of Policy Type and Insurer

When establishing a split-dollar life insurance arrangement, both parties should carefully consider the type of life insurance policy and the insurer to ensure they are selecting the most suitable option for their needs.

Drafting the Split-dollar Agreement

A split-dollar life insurance agreement must be carefully drafted to outline the terms of the arrangement, including premium sharing, death benefit allocation, and cash value accumulation.

Legal and financial professionals should be consulted to ensure the agreement is structured properly and complies with relevant regulations.

Monitoring and Updating the Agreement

Both parties should regularly review and update the split-dollar life insurance arrangement to ensure it continues to meet their respective needs. Changes in life circumstances or financial goals may necessitate adjustments to the agreement.

Establishing a Split-dollar Life Insurance Agreement

Conclusion

Split-dollar life insurance arrangements can play a critical role in financial planning for both employers and employees. By providing affordable life insurance coverage and serving as a retention and reward strategy, these arrangements offer several benefits to both parties.

While split-dollar life insurance arrangements offer numerous advantages, they also come with potential drawbacks, such as complexity, tax considerations, and limited availability.

Both employers and employees must carefully weigh the benefits and disadvantages of this type of arrangement before deciding to pursue it.

Given the complexities of split-dollar life insurance arrangements, it is essential to work with knowledgeable legal, financial, and tax professionals when establishing and maintaining the agreement.

This will help ensure that the arrangement is properly structured, compliant with relevant regulations, and optimized to meet the needs of both parties.

Finally, before committing to a split-dollar life insurance arrangement, employers and employees should consider alternative life insurance options, such as group life insurance plans or supplemental life insurance policies.

This will ensure that they are choosing the most appropriate and cost-effective solution to meet their life insurance needs.

Split-Dollar Life Insurance FAQs

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About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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