Split Dollar Insurance Plans
Want to reward a few key executives with low-cost life insurance — without extending the same benefit to your entire staff? A split dollar life insurance plan makes that possible.
For businesses in Fort Myers and across Southwest Florida, a split dollar arrangement can offer several strategic advantages:
- Attract and retain valuable employees
- Reward key executives
- Fund severance packages and certain other benefit plans
How Does a Split Dollar Life Insurance Plan Work?
Split dollar life insurance is an arrangement between an employer and an employee to share the costs and benefits of a life insurance policy.
Here’s how it works:
- The employer and employee jointly purchase a life insurance policy on the employee’s life.
- Both parties agree, in writing, to split the cost of the premiums.
- They also agree to split the policy’s death proceeds, cash value, and other benefits.
The policy itself can be whole life, universal life, second-to-die (survivorship), or any other cash value policy.
The Two Forms of Split Dollar Arrangements
Split dollar plans generally take one of two structures:
1. Endorsement form The employer is formally designated as the owner of the life insurance contract. The employer endorses the contract to specify the portion of the death proceeds payable to the employee’s beneficiary.
2. Collateral assignment form The employee is formally designated as the owner of the contract. The employer’s premium advances are secured by a collateral assignment of the policy.
Caution: The Sarbanes-Oxley Act of 2002 makes it a criminal offense for a public company to lend money to its executives or directors. This may prohibit the use of the collateral assignment form for these companies.
Why Use a Split Dollar Life Insurance Plan?
Split dollar life insurance for executives is widely used in gift and estate planning and can be an important part of a key employee’s compensation package.
You aren’t required to cover every employee. The coverage, amounts, and terms of a split dollar arrangement are generally not subject to Employee Retirement Income Security Act (ERISA) nondiscrimination rules.
Split dollar plans can be used to:
- Attract, motivate, and retain employees
- Provide low-cost life insurance protection to employees
- Fund severance benefits
- Fund stock purchase agreements
- Fund nonqualified deferred compensation plans
Split Dollar Insurance Benefits
Split dollar life insurance plans offer several advantages:
- Employer-funded coverage: A split dollar plan allows an executive to obtain life insurance coverage using employer funds.
- Secured investment: The business’s investment in the plan is fully secured. If the insured employee dies or their employment ends, the business is reimbursed from the policy proceeds for its premium payments.
- Customizable structure: Split dollar plans can be tailored to meet the objectives of both the employer and the employee.
- Tax-free death benefit: The death benefit from a split dollar plan — both the employer’s share and the share paid to the employee’s beneficiary — is generally free from income tax.
Note: If death proceeds are paid in installments, any interest element in those payments is generally taxable.
Split Dollar Insurance Disadvantages
Split dollar arrangements also come with some drawbacks:
- No employer tax deduction: The business generally receives no tax deduction for its share of premium payments.
- Potential employee tax liability: Depending on how the agreement is structured, employees may owe income tax each year on the value of the economic benefits they receive. Alternatively, if the employer’s premium payments are treated as a series of loans, the employee must pay a reasonable rate of interest — or be considered to have received taxable income equal to the interest that should have been paid.
- Complex tax rules: Split dollar life insurance tax implications can be complicated and require careful planning.
Split Dollar Life Insurance Tax Implications
Current regulations apply two mutually exclusive sets of rules to the taxation of split dollar arrangements:
- Economic benefit regime: Generally applies when the employer owns the policy (endorsement form). The employer is treated as transferring “economic benefits” to the employee, who must include in income the value of the life insurance protection provided, plus any cash value they can access that hasn’t already been taxed in a prior year.
- Loan regime: Generally applies when the employer’s premium advances are secured by a collateral assignment of the policy. Under this regime, the employer is treated as lending the premium payments to the employee.
Before entering into a split dollar life insurance arrangement, it’s important to consult a financial planning professional to assess how current regulations may impact your business.
Frequently Asked Questions
What is a split dollar insurance plan?
A split dollar insurance plan is an arrangement between an employer and an employee to share the costs and benefits — including premiums, death proceeds, and cash value — of a life insurance policy on the employee’s life.
How does split dollar life insurance work?
The employer and employee jointly fund a life insurance policy and agree in writing on how premiums, death benefits, and cash value will be split. The arrangement is structured as either an endorsement form (employer owns the policy) or a collateral assignment form (employee owns the policy).
Is split dollar life insurance only for executives?
No. While it’s commonly used to reward key executives, employers can choose which employees to cover — split dollar arrangements are generally not subject to ERISA nondiscrimination rules.
Are split dollar life insurance death benefits taxable?
The death benefit is generally free from income tax for both the employer’s share and the employee beneficiary’s share. However, any interest paid on installment payments is generally taxable.
Can a business deduct split dollar insurance premiums?
Generally, no. The business typically receives no tax deduction for its share of the premium payments under a split dollar plan.
Does Sarbanes-Oxley affect split dollar arrangements?
Yes. The Sarbanes-Oxley Act of 2002 prohibits public companies from lending money to executives or directors, which may restrict the use of the collateral assignment form for those companies.
The Art and Science of Successful Planning is an independent financial services company helping individuals and businesses utilize a variety of investment and insurance products custom-suited to their needs and objectives. Investment Advisory Services are offered through The Art and Science of Successful Planning, a Registered Investment Advisor registered in the state of Florida. Tyler G. Harrelson, CES, CLTC, CFS, P.A. is a licensed insurance agency doing business as The Art and Science of Successful Planning and is independent of the Registered Investment Advisory.
3949 Evans Ave., Unit 300, Fort Myers, FL 33901 Phone: (239) 489-0084 | Fax: (239) 489-0965
