Split Dollar Life Insurance: A Comprehensive Guide

When it comes to financial planning, life insurance is an essential factor to consider. It provides a safety net for your family, ensuring that they are financially secure in the event of your unexpected death. However, not all life insurance policies are created equal. One option that you may not have heard of is split dollar life insurance. In this article, we will explain what split dollar life insurance is, how it works, and the benefits and drawbacks of this type of policy.

What is Split Dollar Life Insurance?

Split dollar life insurance is a type of life insurance policy where the premiums, death benefit, and cash value are split between a business and an employee or key executive of the business. It is essentially an agreement between the employer and employee to share the costs and benefits of a life insurance policy.

A split dollar life insurance policy can be structured in several ways. The most common type of split dollar plan is the endorsement method. Under this method, the employer pays the premiums on the policy and is the policy owner, while the employee is the insured. The employee’s beneficiaries receive the death benefit upon the employee’s death. The employer can recover some or all of the premiums paid, either by receiving a portion of the death benefit or as a loan against the cash value of the policy.

Another type of split dollar plan is the collateral assignment method. In this method, the employee owns the policy and pays the premiums, but the employer has an interest in the policy and may be entitled to repayment of premiums or other benefits when the policy is terminated.

A split dollar plan can be used for both permanent and term life insurance policies.

How Does Split Dollar Life Insurance Work?

Split dollar life insurance is typically used as a tool for executive compensation or succession planning. The employer and employee enter into an agreement outlining the terms of the split dollar plan. The plan may be funded by the employer, the employee, or a combination of both.

The premiums paid by the employer are considered a loan to the employee, and the employee is taxed on the imputed interest on the loan. The imputed interest is calculated using the applicable federal rate (AFR), which is set by the IRS each month. The employee may be able to deduct the imputed interest as a business expense.

The death benefit is split between the employer and employee, based on the agreement outlined in the split dollar plan. The employer may receive a portion of the death benefit equal to the premiums paid, or may receive a higher percentage based on the agreement.

If the policy is a permanent life insurance policy, it will accumulate a cash value over time. The employer and employee may choose to split the cash value based on the terms of the split dollar plan. The employee may be able to borrow against the cash value of the policy, subject to certain limitations and tax consequences.

Benefits of Split Dollar Life Insurance

There are several benefits to using split dollar life insurance as a tool for executive compensation or succession planning:

Drawbacks of Split Dollar Life Insurance

While split dollar life insurance can provide several benefits, there are also some drawbacks to consider:

FAQ

1. Who owns the policy in a split dollar plan?

The ownership of the policy depends on the type of split dollar plan used. In an endorsement split dollar plan, the employer is the policy owner. In a collateral assignment split dollar plan, the employee is the policy owner.

2. Can a split dollar plan be used for term life insurance?

Yes, a split dollar plan can be used for term life insurance, as well as permanent life insurance.

3. How are split dollar plans taxed?

The tax treatment of split dollar plans depends on the type of plan used and the terms of the agreement. Generally, the premiums paid by the employer are considered a loan to the employee, and the employee is taxed on the imputed interest on the loan. The death benefit may be subject to income tax if it exceeds the premiums paid by the employer.

4. Can split dollar plans be used for retirement planning?

Yes, split dollar plans can be used as a tool for retirement planning. The employee can use the cash value of the policy to supplement their retirement income or to pay for long-term care expenses.

5. Are split dollar plans suitable for all businesses?

Split dollar plans may not be suitable for all businesses. They can be complex to set up and administer, and may be expensive for smaller businesses or those with limited resources. It is important to consult with a financial professional or attorney before implementing a split dollar plan.

Conclusion

Split dollar life insurance is a type of life insurance policy that can provide tax-efficient benefits for executive compensation and succession planning. While it may not be suitable for all businesses, it can be a valuable tool for those who qualify. As with any financial planning decision, it is important to consult with a professional to determine whether split dollar life insurance is right for your business and your employees.