Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
What is it?
An arrangement to share costs and benefits of a life
insurance policy
– typically between employer and employee, but can be used
by others
– can split premiums, death benefits and/or cash value,
dividends, or ownership
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
When is it indicated?
When employer wants:
1. To provide executive with low cost and low outlay life
insurance benefit
2. An alternative to insurance-financed nonqualified deferred
compensation plan for providing pre-retirement death
benefit
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
What is it indicated?
When employer wants:
3. To provide exclusive executive fringe benefit
4. To establish market for stock
•
•
facilitate cross-purchase buy-sell
enable non-stockholding employee to effect a one-way stock
purchase at death of existing shareholder
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Advantages
1. Executive can use employer funds to receive current
benefit with minimal tax cost
2. Employer’s outlay fully secured
3. Can customize plan to meet specific objectives
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Disadvantages
1. No tax deduction for employer’s share of premium
payments
2. Employee pays income tax each year on current
cost of life insurance protection under plan
3. 10 - 20 years before policy cash values are sufficient
to maximize plan benefits
4. Must terminate plan when employee near age 65
5. Unfavorable tax treatment under new regulations
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Design Features: Premium Cost Split
4 major categories
1.
2.
3.
4.
Classic or standard split dollar plan
Level premium plan
Employer pay all
Offset plan
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Design Features: Cash Value and Death
Proceeds Split
Purpose – reimburse employer for share of premium
outlay when employee dies or terminates plan
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Design Features: Cash Value and Death
Proceeds Split
Commonly used cash value / death proceeds split
arrangements:
– employer share is GREATER of:
(1) aggregate premiums it has paid
OR
(2) policy cash value
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Design Features: Cash Value and Death
Proceeds Split
Commonly used cash value / death proceeds split
arrangements:
– employer can only recover up to amount of aggregate
premiums paid
OR
– employer entitled to entire cash value
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Design Features: Policy Ownership
Endorsement method
– Employer owns policy
– Employer responsible for premium payment
– Employer receives death benefit = premiums paid
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Design Features: Policy Ownership
Endorsement method advantages
1. Employer has greater control over policy
2. Simple installation and administration
3. Avoid formal arrangement that might be deemed a loan
for tax and legal purposes
4. Can use existing key employee policy without ownership
change
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Design Features: Policy Ownership
Collateral Assignment
–
–
–
–
–
Employee or 3rd party is policy owner
Employee or 3rd party responsible for premium payment
Employer makes interest free loans = premium
Policy assigned as collateral to employer
Employer recovers aggregate premium payments from
policy proceeds as collateral assignee at death of
employee
– Employee’s beneficiary gets remaining benefits
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Design Features: Policy Ownership
Collateral assignment advantages
– Better protection for employee and employee’s
beneficiary
– Easier to implement using existing policies owned by
employee
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
1. Before September 18, 2003
– Employer could not deduct any part of premium payment
– Lacking clear rules, practitioners took position that either
• no tax liability for increases in employee’s share of cash
value
or
• taxable only when plan terminated and policy ‘rolled
out’ to employee
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
2. After September 18, 2003
Split dollar life insurance defined as
“any arrangement between an owner and a non-owner of
a life insurance contract”
that also satisfies the following three criteria:
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
3 Criteria for Defining Split Dollar Life Insurance:
1. Either party pays all or a portion of the premiums,
including a payment by means of a loan secured by the
life insurance contract.
2. One of the parties can recover a portion of the premiums
paid from the contract (or payment is secured by the
contract).
3. The arrangement is not part of a Section 79 group-term
life insurance plan unless the plan provides permanent
benefits.
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
• Two mutually exclusive regimes for taxing split dollar
life insurance
– economic benefit regime
– loan regime
• Must ascertain owner of policy to determine which
regime applies
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
Ownership rules
– Named policy owner generally treated as such under
regulations
– If two or more owners all have incidents of ownership with
respect to an undivided interest in the contract, each
treated as owner of separate contract
– If two or more owners and not all have incidents of
ownership, first named owner considered owner for
purposes of regulations
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
Economic benefit treatment
Employee must count value of life insurance or other benefit
provided under a split dollar plan as additional taxable income
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
Rollout (transfer of contract)
– Transfer of contract to non-owner generates income for
non-owner equal to fair market value of contract less
various sums paid by non-owner to transferor or taken as
income by the non-owner
– If contract subject to substantial risk of forfeiture,
employee can delay tax to sometime after the rollout
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
Loan treatment
– Default treatment of plans that do not meet economic
benefit regime requirements
– Generally, loan amount is deemed taxable income to
recipient (usually employee), specific details governed by
tax law and loan characteristics such as interest rates or
date loan payable
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
Effective date
• Split Dollar regulations apply to arrangements
entered into after 9/17/2003 and arrangements
materially modified after 9/17/2003.
• “Materially modified” is not defined, but a list is
provided to show what is not a material modification.
• 1035 exchanges are not on that list.
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
3. Split dollar life insurance death benefits income tax
free
– employer’s share
– employee’s beneficiaries share
– note: some transfers of insurance policies are exempt
from transfer for value rules, some are not
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
4. Incidents of ownership affect estate tax liability
– if employee had no incidents of ownership, death benefit
excluded from employee’s estate for estate tax purposes
unless policy proceeds payable to estate
– if employee is controlling shareholder, corporation’s
incidents of ownership in policy will be attributed to
controlling shareholder, death proceeds included in
employee estate
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Tax Implications
5.
May be federal gift taxes to pay if someone other
than employee owns insurance policy used in split
dollar plan
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
ERISA Requirements
Split dollar plans are ‘welfare benefit’ plans under
ERISA
–
–
–
must have written document, “named fiduciary,” and
formal claims procedure
can escape ERISA reporting and disclosure if is ‘insured’
plan maintained for ‘a select group of management or
highly compensated employees’
if cover more than select group, must provide SPD
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
True or False?
1. Split dollar plans are best suited for executives in
their late 50’s and early 60’s.
2. In most split dollar plans, the employer’s outlay is
fully secured at all times.
3. The employer receives a tax deduction for its share
of premium payments under a split dollar plan.
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
True or False?
4. Under the classic or standard split dollar plan, the
employer and employee split the cost of the life
insurance premium equally.
5. An employee who terminates employment before a
split dollar plan matures can be held personally
responsible for reimbursing employer for aggregate
premiums paid.
6. The employee owns the policy under the
endorsement method of policy ownership.
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
True or False?
7. Recently, significant changes have occurred in the
tax laws governing split dollar life insurance.
8. Split dollar plans are exempt from ERISA
regulations.
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Split-Dollar Life Insurance
Chapter 42
Employee Benefit & Retirement Planning
Discussion Question
Is a split dollar arrangement a useful compensation
technique for a partner, proprietor, or shareholder
employee of an S corporation?
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