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Split-Dollar Insurance for Businesses

"Split-Dollar Insurance" is not an insurance policy. It is a method of paying for insurance coverage. A split-dollar plan is an arrangement between two parties that involves "splitting" the premium payments, the cash values, the ownership of the policy, and the death benefits. The arrangement generally involves permanent cash value insurance such as whole life, universal life, variable universal life or a term/whole life blend. An insurance policy with substantial cash value acquired through a split-dollar arrangement can be used by an employee as a source of supplemental retirement income.

By splitting the premiums and ownership with the employee, the employer is essentially guaranteed of receiving the cost of the employer’s contributions to the plan. At the time of death of the insured-employee, the employer will receive an amount equal to the total premiums paid and the beneficiaries designated by the employee will receive the remaining death benefit.

For simplicity sake, let’s look at a situation involving a small business owner and an employee. In this case, the employer takes out a whole life cash value life insurance policy on the employee and agrees to pay the cash value portion of the premium. The employee agrees to pay the remainder of the premium payments (i.e. mortality and expense portion). Upon the death of the insured, the employer would be repaid the amount of funds contributed to the policy and the employee’s designated beneficiary would be paid the remainder of the death benefit.

As an example, a $200,000 whole life insurance policy is purchased for an employee. As part of the agreement, the owner agrees to pay the cash value portion of the premium and at the time of death of the employee, the owner has contributed $43,000 in premiums. Upon the death of the insured employee, the owner would be returned the $43,000 contribution and the employee’s designated beneficiary would be paid $157,000.

Many businesses find a split-dollar arrangement an effective and economical way to obtain and retain key employees by helping them to achieve some sense of security at relatively no cost to the employer and at little cost to the employee. Split-dollar plans can also be very effective where large amounts of insurance are needed by a partner or a business-owner’s estate.

Since these agreements are informal agreements (i.e. not tax qualified benefit plans), the can be discriminatory in terms of employee selection; they do not require IRS qualification; and, the premium payments are not tax deductible. However, the refunded contributions to the employer and the death benefits to the insured’s beneficiaries are tax free.

Split-dollar insurance programs can get very sophisticated and can be used for any number of purposes depending on the type of business (e.g. S-Corp, C-Corp, etc) or the purpose intended (e.g. gifting, estate taxes, switch-dollar, etc.) which are beyond the scope of this discussion.

There are generally three methods of policy ownership in a split-dollar arrangement:

• The Collateral Assignment Method – in this method the employee purchases the life insurance directly and is considered the owner of the policy. The employee then makes a collateral assignment of the policy to the employer in return for the employer to pay the premiums, or part of the premium, on the policy. The employer can pay the premiums and be confident of repayment because the employer holds the policy as collateral. At the time of death, the employer would be repaid the amount of the premium payments contributed to the policy and the balance would be paid to the employee’s designated beneficiaries.

• The Endorsement Method – traditionally the employer is the purchaser and owner of the insurance policy and there is a separate agreement between the employer and the insured employee defining the employee’s rights in the insurance policy. The employer typically names itself as the beneficiary of an amount of the proceeds equal to the cash value of the policy at the time of the insured’s death and, by endorsement, provides that the insured’s beneficiaries have the right to the portion of the proceeds in excess of the cash value (i.e., the “at risk” portion).

• The Usual Arrangement – under this method, the insured is the original owner of the policy with a named beneficiary and by absolute assignment transfers to the employer a portion of the policy values equal to the premiums paid by the employer. The employee retains all ownership rights; however, when the employee dies the proceeds are first applied to the repayment of the employer’s premiums with the balance being distributed to the beneficiaries selected by the insured employee. Should the employee leave the employ of the employer, any cash value in the policy would be used to repay the employer.

Often times the employee’s ownership is organized in an irrevocable trust or other such legal arrangements which can be used in a number of estate planning and asset protection plans. Specific legal assistance should be obtained to discuss the use of split-dollar arrangements for other than very simple purposes.

Any agreements and insurance policies within a business must be integrated with the overall plan and objectives of the business. Careful consideration must be given to the selection of a plan which is right for your business and to the method of funding your plan.

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This material contains only general descriptions and is not a solicitation to sell any insurance product or security, nor is it intended as any financial or tax advice. For information about specific insurance needs or situations, contract your insurance agent. Our articles are intended to assist in educating you about insurance generally and not to provide personal service. They may not take into account your personal characteristics such as budget, assets, risk tolerance, family situation or activities which may affect the type of insurance that would be right for you. In addition, state insurance laws and insurance underwriting rules may affect available coverage and its costs. If you need more information or would like personal advice you should consult an insurance professional. You may also visit your state’s insurance department for more information.