A split-dollar life insurance agreement (or “split-dollar plan”) is a strategy generally used as an employer benefit or for estate planning involving life insurance. It’s an agreement between two or more parties to share the ownership, costs, and benefits of a permanent life insurance policy, like whole life.
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Let’s say that you’re a large corporation. What would happen financially if your CEO died suddenly? Likely, there would be a significant impact to the organization’s bottom line. As you deal with the sudden departure and work to find a replacement and transition to new leadership, millions of dollars could be at stake. If the company is publicly traded, that impact is likely to be felt immediately in the stock price.
Split-dollar plans were designed to help in this situation, but other uses for them have also been found. It’s an agreement to share a life insurance policy between two (or more) parties. Usually, one pays the premium and both sides get some of the benefits paid upon the insured’s death. Businesses have long used them in compensation packages for high value employees as a desirable benefit in addition to helping the company cover losses should something happen. Today, there are different applicable laws and tax implications depending on how you structure it.
There is always a permanent life insurance policy with cash value as part of the agreement, but the term “split-dollar agreement” refers to the contract outlining how the parties will split the life insurance policy.
Split-dollar plans are usually used to help businesses address the financial risk of losing a high value employee unexpectedly. Most often, the premiums are paid by the employer, and the benefits are split between the employer and the family of the deceased. Both sides benefit from the agreement, but only one life insurance policy is needed.
New laws were passed in 2003 that changed the way taxes are treated in these agreements, and that has made them less desirable as part of a compensation package. They are still used, but not as widely as they once were.
The life insurance policy itself and its benefits do not change with the addition of a split-dollar agreement. The additional contract outlines how different aspects will be divided and how taxes will be applied to the policy.
First, the parties should agree on the terms of a policy, commonly whole life insurance. It provides a guaranteed benefit 1 , coverage that will last a lifetime as long as premiums are paid when due, and premiums that will never change. Permanent life insurance policies also provide cash value—funds that can be accessed while the insured is still alive 2 .
Second, a contract is put into place to outline how the parties will split up the costs and benefits of the policy. Who pays the premiums? Who is the owner of the policy? Who names the beneficiaries? And how will the life insurance benefit be split? Those are all important aspects of the agreement that will need to be clearly outlined, as well as how and when the policy will end. Often, the employer will pay most or all of the premiums, and the benefit will be split between the company and the family of the deceased.
The way taxes are applied to a split-dollar agreement is different depending on who owns the policy. When you own it and your employer pays the premiums, you normally designate some of the benefits to the employer with a collateral assignment agreement. The premium payments are taxed as if your company is giving you an interest-free loan, called a loan regime.
If the employer owns the policy and you and your family are to receive some of the benefits, that is designated by an endorsement agreement. Those benefits are taxed as an economic benefit, meaning it’s considered a form of pay and calculated annually.
In most cases, a simple individual life insurance policy is going to be better for nearly everyone shopping for coverage. That said, under split-dollar plan, life insurance policies cover a couple of important instances very well. If one of the following applies to you, they are worth considering.
Historically, split dollar policies were used to cover the potential losses a company could incur if its CEO or another very important employee passed unexpectedly. They are still often used that way today, especially at publicly traded companies. Small-business partners and family-run businesses may want one in place as well to allow time to find a replacement for high-value roles.
Benefits packages for top employees are very competitive and can include a lot of incentives, like company-paid split-dollar life insurance. While less common now, because of the tax changes, it can still help a company compete for top talent.
For example, in 2021, if you applied a split-dollar agreement to a personal policy, it’s often called private split-dollar life insurance. In these cases, it’s used as an estate planning tool to minimize taxes on wealthy families when passing significant financial assets to their heirs. If you’re concerned about your transfer of wealth, our agents can help you with estate planning.
Life insurance is an important financial tool. Whether it is an individual policy, or an employer provided group life policy, or even a split-dollar agreement, the right mix can ensure your family’s financial future and safety. Our experienced agents can help you customize a suite of products that provide the coverage you need for your unique situation.
Neither New York Life Insurance Company, nor its agents, provides tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.