Split Dollar Life Insurance

Split Dollar Life Insurance

Split dollar life insurance is an arrangement between an employer and an employee to share the costs and benefits of a life insurance policy. Specifically, the parties join together to purchase an insurance policy on the life of the employee and agree, in writing, to split the cost of the insurance premiums, as well as the policy's death proceeds, cash value, and other benefits. The actual life insurance policy used can be whole life, universal life, second-to-die (survivorship), or any other cash value policy.

Split dollar arrangements usually take one of two forms. Under the endorsement form, the employer is formally designated as the owner of the life insurance contract and endorses the contract to specify the portion of the death proceeds payable to the employee's beneficiary. Under the collateral assignment form, the employee is formally designated as the owner of the contract, and the employer premium advances are secured by a collateral assignment of the policy.

Split dollar life insurance is widely used in gift and estate planning and can be an important part of the compensation package of many key employees. You don't have to cover all of your employees--the coverage, amounts, and terms of the split dollar arrangement are generally not subject to Employee Retirement Income Security Act (ERISA) nondiscrimination rules. Split dollar plans can be used to:

Split dollar life insurance offers a number of advantages:

• A split dollar plan allows an executive to obtain life insurance coverage using employer funds.
• The investment by your business in the plan is fully secured. If the insured employee dies or his or her employment is terminated, your business is reimbursed from the policy proceeds for its payment of premiums.
• Split dollar plans can be customized to meet the objectives of both employer and employees.
• The death benefit from a split dollar plan (both the employer's share and the share going to the beneficiary of the employee) is generally free from income tax.

Note: If the death proceeds are paid in installments, any interest element in the installment payments will generally be taxable.

• Your business will generally receive no tax deduction for its share of premium payments under the split dollar plan.
• Depending on how the agreement is structured, employees may have to pay income taxes each year on the value of the economic benefits provided to them. Alternatively, if the employer's premium payments are considered a series of loans to the employee, then the employee must pay a reasonable rate of interest to the employer. If the employee does not do so, the employee is considered to have received taxable income up to the amount of interest that should be paid. 
• Tax rules regarding split dollar life insurance are complicated

Reverse Split Dollar

Reverse split-dollar takes its name as the reverse of a conventional split-dollar plan.  In regular split-dollar, the employee is entitled to a substantial portion of the death benefit proceeds, and the employer retains an interest in the cash value of the life insurance policy.  

Reverse split-dollar reverses the benefits found in regular split-dollar.  The reverse split-dollar strategy is to apply the tax principles for regular split-dollar in reverse to achieve favorable, but different business and tax results.

In a reverse split-dollar plan, the employee owns the cash value portion of the policy, and the employer owns the policy's death benefit.