Best Guide Split Dollar Life Insurance 2021
Best Guide Split Dollar Life Insurance 2021
What is Split Dollar Life Insurance
Life insurance can be an important part of a business owner’s financial strategy.
It can also be a great benefit to offer to key employees.
However, sometimes the cost can be prohibitive.
With split-dollar life insurance, the cost of life insurance can be managed by splitting it up.
To be clear, split-dollar life insurance is not an insurance product but rather an arrangement to purchase and fund life insurance between two parties, generally an employee and an employer.
Basically, an agreement is made under which a life insurance policy is purchased on an individual.
The employer will pay all or a portion of the premiums on the policy, depending on the arrangement.
When the individual dies, the employer receives a portion of the death benefit equal to the amount paid in premiums. The remaining benefit goes to the individual’s beneficiaries.
Example of a Split Dollar Life Insurance – Best Guide Split Dollar Life Insurance 2021
For example, if a $200,000 policy were purchased for an individual who died after the employer had paid $28,000 in premiums, then the employer would get back the money it had paid in premiums and $172,000 would go to the insured individual’s beneficiaries.
This agreement is attractive to both parties because the employer recoups its money and the employee receives a life insurance policy at a better rate because the company is picking up all or a portion of the cost. The death benefit is free of income tax for both parties as well.
How can the Split Dollar Life Insurance be used
A split-dollar life insurance arrangement can be used for a variety of reasons.
- It can be used to fund a buy-sell agreement.
- It can help recruit and retain quality executives.
- Business owners who might not otherwise be able to afford life insurance might benefit from a split-dollar arrangement.
Split-dollar life insurance policies can be set up in different ways.
Usually, the individual owns the policy and designates beneficiaries, then by absolute assignment transfers to the employer an amount equal to the premiums paid by the employer.
In this case, the individual retains all ownership rights, but when the individual dies, the employer is reimbursed before the individual’s named beneficiaries are paid. If the individual leaves the company, any cash value in the policy would be used to repay the company.
In other arrangements, the policy can be purchased by the employee and assigned to the employer as collateral in exchange for the employer paying the premiums.
Because the company holds the policy as collateral, it can be confident that it will recoup the money spent on the insurance premiums.
In some cases, the employer can take out a life insurance policy on the employee. The employer names itself as a beneficiary of an amount equal to the cash value and designates that any funds in excess of that amount will be paid to the individual’s beneficiaries.
Cost of Split Dollar Life Insurance
The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable.
As with most financial decisions, there are expenses associated with the purchase of life insurance.
Policies commonly have contract limitations, fees, and charges, which can include mortality and expense charges. In addition, if a policy is surrendered early, there may be surrender charges and income tax obligations.
The Benefits of Split-Dollar Life Insurance
For those unfamiliar with split-dollar life insurance arrangements, this is a program in which an employer agrees to loan dollars to an employee (generally over a period of seven years) that are invested in a cash accumulation life insurance policy.
Unlike a traditional life insurance policy, however, where the goal is to pay the lowest premium for the highest amount of death benefit, the policies used in these programs do the opposite and pay the highest premium for the lowest amount of death benefit.
This approach minimizes policy charges and allows the policy’s cash value to grow as rapidly as possible with the least amount of drag.
At some point – either out of policy cash value during the employee’s lifetime, or out of the death benefit at the employee’s death, depending upon the structure of the agreement – the loan from the employer will be repaid.
But in the meantime, policy cash value in excess of the loan balance can be accessed by the employee income tax-free to supplement cash flow in retirement.
Think of the arrangement as analogous to the employer funding a Roth IRA for the benefit of the employee, with a potential death benefit as an added bonus.
Split Dollar Life Insurance Tax Treatment
The policy in the split dollar plan may be owned by the employer or by the insured. Under the most recent IRS rules, the tax treatment of the plan depends on who owns the policy. In the traditional split dollar plan the employer owns the life insurance policy. However, the policy may be owned by:
- The employer in an endorsement split dollar plan
- The insured in a collateral assignment split dollar plan,
- or both the employer and the insured, jointly.
The tax treatment that is given to a split-dollar plan depends upon which party-the employer or the executive-owns the policy. If the employer owns the life insurance policy, e.g. in an endorsement split-dollar plan, the employee has a reportable economic benefit based on the current value of the term insurance benefit provided and the dividends applied to his or her benefit.
The method by which employee taxation occurs under an employer-owned policy may vary, depending upon the particular situation.
Split Dollar Life Insurance Estate Planning
Split-dollar life insurance doesn’t have to be between a business and an employee, though.
For high net worth individuals, it can be used as an estate planning tool.
This usually involves a person putting a permanent life insurance policy into an irrevocable life insurance trust (ILIT).
Once in the trust, you don’t have control over the policy. If done correctly, the idea is the policy won’t be included as part of your estate and can therefore avoid the estate tax.
This is only for high net worth individuals because the average person won’t be subject to the estate tax.
It only impacts you if you use your entire $11,580,000 estate and gift tax exemption. Most people come nowhere near this.
This tax planning concept is complex. It requires specific planning based on your situation.
Make sure to consult the applicable experts. They can let you know if this will work for you and how to enact it.
TYPES OF SPLIT DOLLAR LIFE INSURANCE ARRANGEMENTS – ENDORSEMENT AND COLLATERAL ASSIGNMENT
Endorsement Split Dollar
Endorsement split dollar is primarily used when a company owns a policy on your life and endorses some or all of the death benefit to you or your trust.
Endorsement split dollar is mostly used for business planning.
It is a cost-effective way to for an employer to provide protection on themselves or a key executive. It can also be used to provide supplemental retirement income.
Oftentimes, endorsement split dollar is used as a non-qualified deferred compensation program to create golden handcuffs.
Life insurance is a tax-efficient vehicle that can be used to fund deferred compensation payments for a retiring employee.
Under this arrangement, the participant contributes the term cost of the death benefit for their beneficiaries as a survivor benefit.
Alternatively, the company can bonus the annual term cost as additional taxable compensation to the participant.
Benefits of Endorsement Split Dollar
Endorsement Split Dollar is most beneficial as an executive benefit.
Since the cost is limited to the economic benefit it offers low-cost death benefit protection and/or supplemental retirement income. It can be used by a corporation to provide key-person protection on a valued employee or owner.
And, can be an attractive option when establishing and funding a buy-sell agreement.
Endorsement Split Dollar allows for cost recovery from the death benefit proceeds.
Collateral Assignment Split Dollar
Collateral assignment split dollar is generally used by individuals or companies when the insurance policy is owned by a trust.
The life insurance policy is either an individual policy or survivorship policy.
The owner of the policy (trust) pledges the cash value and death benefit to repay premiums advanced by the non-owner.
This arrangement is usually established between an individual and their trust. However, an individual’s company can advance premiums using corporate dollars.
The policy is then collaterally assigned to the individual or company advancing the premiums as security for repayment of premiums.
Benefit of Collateral Assignment Split Dollar
Collateral Assignment Split Dollar is most often used for estate planning.
It can provide estate liquidity while minimize gift taxes and use of an individual’s lifetime exemption. Since economic benefit rates can be low, gift taxes can be minimized while gifts of premiums are leveraged with life insurance.
Collateral Split Dollar can also be beneficial for business buy-sell planning.
FINAL THOUGHTS ON SPLIT DOLLAR LIFE INSURANCE
Best Guide Split Dollar Life Insurance 2021
Split Dollar Life Insurance arrangements are ideal for companies looking to provide additional benefits to key employees, and for individuals interested in minimizing gift tax and use of their lifetime exemption for estate tax purposes.
There are number of benefits for using a Split Dollar arrangement.
Your need for life insurance, age, interest rate environment, and premium sources will dictate which arrangement may work for you.
When designed effectively, the agreement benefits both the employee and the employer, however, tax code defining the use of a split dollar plan is complex and is subject to revision.
Organizations will want to consult with their tax advisors and other executive benefits consultants before entering into this type of arrangement.
If a split-dollar life insurance program is under consideration, a thorough assessment of potential risks and rewards must be conducted.
Having an independent expert who can facilitate the process, deliver a balanced evaluation of options and ensure each party is asking the right questions and getting the answers they need is critical to making an informed decision.