Understanding employee benefits can be confusing.
Mixing in life insurance makes it even more complicated, especially a split-dollar life insurance plan.
But it doesn’t have to be:
While this particular benefit isn’t offered that often to employees, the concept of how it works is simple. Once you figure it out, you will be able to decide if a split-dollar agreement is for you.
In this post, I will go over the definition of split-dollar life insurance, how it works, how to terminate one if you are already in a contract, and much more.
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What Is Split Dollar Life Insurance?
Split-dollar life insurance is not a life insurance policy. It’s actually a type of contract, usually between an employer and an employee, to split the costs and rights to share in the life insurance proceeds if the insured (employee) dies. These agreements are usually for whole life or permanent policies, and what makes them less appealing is how complicated they can be to structure and how they are taxed. When dealing with a split-dollar life policy, you need to figure out who will own the policy, how the premium payments will be made, and how the benefits will be divided.
How Is Split-Dollar Life Insurance Taxed?
If you (the employee) owns the life insurance policy and your employer is paying the premiums, it will be taxed as a “split-dollar loan, also called a collateral assignment using the loan regime.”
However, if the employer owns the policy and gives you policy benefits, it will be taxed under the “endorsement agreement using the economic benefit regime.”
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How Does Split Dollar Life Insurance Work?
The majority of people choose one of the two ways below when arranging a split-dollar agreement; however, there is more than one way to make them work.
When Your Employer Owns The Life Insurance Policy
Our goal is to keep everything in “Plain English,” so I will do my best.
If your employer is the owner of the life insurance policy, but you are the recipient of the benefits, the agreement is considered an “endorsement agreement using the economic benefit regime.”
Now, breaking these two things down looks like this:
An endorsement agreement states that you will have all the policy benefits signed over to you or someone you designate; however, the employer keeps ownership rights of the policy.
The economic benefit part of this agreement refers to the fact that the IRS sees this type of split dollar arrangement as a benefit to you but not a loan. This means that the IRS will be taxing you on the value of the life insurance policy.
When You (The Employee) Owns The Policy
If you will be the owner of the life insurance policy, but your employer will be making the premium payments, your split-dollar arrangement is known as “a collateral assignment using the loan regime.”
A collateral assignment is when the policy belongs to you (the employee), but some of the policy benefits are assigned to your employer. This lets the employer lend you money to make premium payments without worrying about not getting repaid. The portion you sign-over will act as collateral for the loan. If you die or leave the company, the employer benefits will kick in, making sure they get repaid.
A loan regime is about how the IRS will tax this agreement. With your employer lending you money, there needs to be some type of interest borrowed on that amount. The amount of tax you will owe will depend on the interest rate your employer gives you.
It’s going to be up to you and your employer to develop an agreement and process that works for both of you.
Is Split Dollar Life Insurance Best For You?
While split-dollar life policies are less common because of a change in their tax treatment, if your employer offers them, they can still be a valuable benefit to have, precisely when it comes to the planning of your estate.
You can use these policies for:
Endorsements
Collateral Assignment
Estate Planning
Funding Buy-Sell Agreements
Cross Endorsements
How these policies will work and benefit you will be determined by the agreement and policy you choose.
How To Terminate Split-Dollar Life Insurance?
Split-dollar life insurance policies can be terminated by the employee’s death or at a later date noted in the agreement.
If the employee dies unexpectedly, depending on the agreement, the employer will recover any amount owed in loans and premium payments made on the policy.
Termination can also happen when the employee leaves the place of employment; all of the benefits owed to the employer will kick in according to the agreement.
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Taking Action
Split dollar policies aren’t all that complicated in how they work. The hard part is figuring out if the way they will be taxed and structured works best for you and your employer.
These plans won’t work for everyone; however, be sure to always have life insurance outside of your employer. You can click here or on any of the above buttons to get a few quotes and compare rates to get a policy started.
Frequently Asked Questions
What is a split dollar life insurance plan?
A split-dollar life insurance plan is an agreement between an employee and employer on how they will share the death benefit and premium costs of a permanent or whole life insurance policy.
What is one of the major disadvantages of split dollar plans?
For a business owner, they usually won’t receive any tax deductions for their share of the premium payments under a split dollar life insurance plan. There is also a chance that as an employee, you could be subject to taxes on the value of the benefits provided under the split-dollar plan.
Who pays the premiums in a split dollar plan?
The employer pays the premiums in a split dollar plan and is also usually the policy owner. There are some occasions where the employee may own the policy; however, the majority of the time, this type of policy is offered to employees as a benefit.
