Using life insurance in a split dollar plan
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A split-dollar plan is a strategy that allows the use of life insurance to benefit two parties, typically an employer and a high-level employee. This article can help you understand:
What is a split dollar plan
How the plan works
Benefits for companies and employees
Legal considerations1
What is a split dollar plan?
A split-dollar plan is an agreement that details how the premium, cash value, and death benefit of a life insurance policy will be split between two or more parties. For employers, a split dollar plan serves as an attractive incentive to recruit high-level executives or highly talented individuals. For employees, it offers valuable life insurance coverage with minimal out-of-pocket expenses.2,3 Generally, a split-dollar agreement identifies the following elements:
Who owns the policy
Which portion of the premium each party will pay
Which portion of the death benefit and cash value each party will receive
The agreement also commonly specifies the period of coverage for the plan and how the plan will terminate, usually at retirement, termination of the employee, or the death of the employee.
What are the benefits?
Split-dollar agreements that utilize life insurance can be mutually beneficial, with employees and employers reaping financial gains. Specifically, employers benefit from the structure of the policies, which allow them to choose the recipient of the plan, the amount of the benefit, and when the benefit is given. Additionally, split-dollar plans are not subject to the rules and restrictions commonly found in qualified benefit plans such as pensions or 401Ks. Finally, these plans can be economically advantageous as the employer owns a portion of the cash value at least equal to its outlay, and can recoup this cost when an employee leaves or passes away.
Employees can benefit from split-dollar life insurance plans as well. For starters, employers are responsible for paying the bulk of the premiums, meaning the cost for the employee is reduced. Depending on the plan structure and the exit strategy for the plan, the employee may end up with full ownership of the policy. At that point, the employee may be able to make tax-efficient loans and withdrawals from the policy to provide supplemental retirement income.
Split-dollar plans with life insurance
The two most common forms of split-dollar life insurance are “economic benefit” and “loan regime” arrangements. In an economic benefit arrangement, the employer owns the policy, pays the premiums, and owns the policy cash value. The death benefit is split between the employer and the employee as detailed in the split dollar agreement. The employee names the beneficiary of their portion of the death benefit and pays taxes on the economic benefit on their portion of the death benefit. Some employers provide an additional bonus to cover the cost of the taxes on the economic benefit.
With a loan regime split dollar arrangement, the employee owns the policy that funds the arrangement, and the employer loans the employee money to pay the premium at the Applicable Federal Rate (AFR). The specific AFR that may be used for the loan is dependent upon whether the loan is structured as a demand or term loan, and if it is the latter, the length of the term. The employer receives a portion of the cash value and death benefit equal to the loan, until it is repaid. At the time of rollout (when the arrangement ends), the loan can be forgiven or potentially repaid from policy cash values.
Legal considerations
Although split-dollar plans have existed for some time, regulatory changes have added restrictions to what some already viewed as a complex life insurance option. Specifically, in 2002 the IRS issued updated guidance regarding the types of split-dollar agreements that may be formed, including the loan regime. The revised regulation, which has been in effect since September 2003, codified the use of economic benefit and loan arrangements, and specified the tax treatment of each. This allowed employers to continue to use corporate dollars to fund split dollar agreements funded with life insurance.
Before entering into a split-dollar agreement, employers and employees are advised to consult financial and legal professionals to ensure that both parties' interests are reflected in the agreement.
Split dollar plans can also be used for estate planning
Finally, split dollar plans aren’t just for employers and employees. Private citizens can also leverage this tool, which can be particularly useful when conducting high-value estate planning. Wealthy people can create private split-dollar life insurance agreements, which can help reduce estate taxes. This could be an option to explore if you have significant wealth you want to protect for future generations. A financial professional can provide critical information to help inform your decision.