Split-Dollar Life Insurance Explained

Split-dollar life insurance is a great benefit and estate planning tool. Here are the facts.

Split-dollar insurance is a contract between two parties that shares the benefits and costs of a permanent insurance policy. Split-dollar plans are often between employees and employers. The executive compensation package will include the split-dollar plan. These packages became less common after a change in the tax treatment for 2003.

While you may not be offered a split-dollar life insurance benefit anymore, wealthier Americans use private versions in estate planning. If you are willing to go through the financial hoops, there are still tax benefits available.

What is split-dollar insurance for life?

Split-dollar life insurance can be described as a simple idea. Split-dollar life insurance is a business that pays for your life insurance while you work. You get the benefits without having to pay upfront. How everything is taxed and structured is the tricky part.

There are three choices when it comes to split-dollar life insurance:

  • Who will be responsible for the policy?
  • How will the benefits be divided?
  • How payments are made.

There are many ways to make a split-dollar deal, but these two stand out.

Once you have the policy

If you are the owner of the life insurance but your employer pays the premiums, this is known as a collateral assignment using a loan regime.

Collateral assignment means that the policy is yours, but certain benefits are transferred to your employer. Your employer can lend you money to pay premiums without having to worry about repayment. The signed-over portion serves as collateral. The benefits you have signed over to your employer are guaranteed that the loan is repaid if you die or leave the company.

The IRS terms “Loan Regime” and “Reporting regime” describe the tax treatment of these agreements. The employer will loan you money and you must pay interest. It would be an untaxed benefit and a free loan. The interest rate charged by your employer will determine the amount of tax that you will owe.

Publicly traded companies cannot use this option, since the Sarbanes-Oxley Act bans them from lending money to their executives.

Your employer is the owner of the policy

The endorsement agreement uses the economic benefit system.

An “endorsement agreement” is a contract where your employer retains ownership of the policy, but you sign the benefits over to yourself or someone you designate.

The IRS defines economic benefit as the way it treats split-dollar insurance agreements. This means that your employer is providing you with some benefit, but not a loan. This means that you will be taxed on life insurance value provided by your employer. The value of this insurance is determined either by the IRS or the insurance company.

Employees can get split-dollar life insurance

Employees can enjoy many benefits from split-dollar agreements. For high-earners, extra life insurance coverage is a boon.

You may also be eligible for cash value and taxes. The cash value is money that you might be able borrow or withdraw later in your life, or when you retire. Every policy is different, so your employer can provide more information about the benefits you will receive.

Collateral assignment is the most popular form of split-dollar insurance. This allows you to own the policy and pay your employer with loans. Accounting can be complicated because the IRS considers each premium payment a new loan.

Split-dollar life insurance tax treatment can be confusing. Split-dollar agreements were created by the IRS to close loopholes. However, this meant that a list of possible ways for companies to treat them was established. These arrangements are more complicated to structure and execute because there are fewer options.

Split-dollar life insurance in estate planning

Split-dollar insurance isn’t only a benefit for employees. Split-dollar life insurance agreements can be made by wealthy individuals. These private arrangements usually include an irrevocable insurance trust or an ILIT.

ILITs allow you to transfer your life insurance benefits into a tax-advantaged trust for less future control. The “irrevocable part of the trust basically means that you can’t access any trust assets. The main benefit of an ILIT is that it won’t be included in your estate, escaping estate taxes.

This doesn’t really matter for most people. Estate taxes are only applicable to the wealthy. They kick in when assets exceed $11.58million at death.

A tax advisor is recommended for anyone considering splitting-dollar life insurance as part of their estate planning.