What is a split-dollar life insurance policy?

Life insurance can play a crucial role in a business owner’s financial strategy. It can also serve as a valuable benefit for key employees. However, the cost sometimes makes it hard to implement. Split-dollar life insurance helps manage these costs by dividing the expenses between two parties.

What is Split-Dollar Life Insurance?

Split-dollar life insurance is not a separate insurance product. Instead, it is an arrangement between two parties usually an employee and an employer to purchase and fund a life insurance policy.

Under this arrangement, a life insurance policy is purchased on an individual. The employer pays all or part of the premiums, depending on the agreement. When the individual dies, the employer recoups its share of the premiums, while the remaining death benefit goes to the individual’s beneficiaries.

Example:

If a $200,000 policy covers an individual who passes away after the employer has paid $28,000 in premiums, the employer receives $28,000. The remaining $172,000 goes to the individual’s beneficiaries.

This arrangement benefits both parties. The employer recovers its costs, and the employee receives life insurance at a lower effective rate. Additionally, the death benefit is income-tax-free for both parties.

Uses of Split-Dollar Life Insurance

Split-dollar arrangements can serve multiple purposes:

Fund a buy-sell agreement
Recruit and retain key executives
Provide affordable life insurance to business owners who might not otherwise qualify

How Split-Dollar Policies Work

There are several ways to structure split-dollar life insurance:

Individual Ownership with Absolute Assignment

The employee owns the policy and names beneficiaries.
The employee transfers an amount equal to premiums paid by the employer.
At death, the employer recoups its costs first. The remaining benefit goes to the employee’s beneficiaries.
If the employee leaves the company, any cash value repays the employer.

Employer as Collateral

The employee purchases the policy and assigns it to the employer as collateral.
The employer pays premiums in exchange for the policy rights.
The company ensures it recoups the money spent on premiums.

Employer-Owned Policy

In some cases, the employer purchases the policy directly on the employee.
The employer receives an amount equal to the cash value.
Any excess funds go to the employee’s beneficiaries.

Costs and Considerations

Life insurance costs depend on age, health, and the type and amount of coverage. Before implementing a split-dollar strategy, confirm the individual is insurable.

Policies come with fees and charges, which may include: