Split-Dollar Life Insurance
A split-dollar plan allows for the splitting of cash values and the death benefit between two entities or individuals. Split-dollar has been utilized for years in funding large-premium life insurance.
This type of plan can be used by individuals to fund expensive premiums, or is often used by corporations to fund a policy for an executive to provide him or her future benefits as well as the company. When an executive dies prematurely, there is a loss of revenue until that executive is replaced, the new hire learns the new job and begins performing.
In 2003, final split-dollar regulations changed how split-dollar is treated. This has led to a reduction of split-dollar plans, but it still remains a viable planning tool.
In a typical split-dollar arrangement, the employer pays all or most of the policy premiums in exchange for an interest in the policy cash value and death benefit. In the past, the employee had to pay the term cost each year for the year’s coverage.
On Jan. 28, 2002, the IRS issued Notice 2002-8 wherein all new arrangements fall under one of two categories in split-dollar taxation. The ownership of the policy determines which category applies.
The employer owns the policy and pays the premiums. Through an endorsement of the policy, the employee is given the right to name the beneficiary of the death benefit. The employee is given the right to receive cash value of the policy which exceeds the premiums paid by the employer. The net death benefit is payable to the beneficiary at death.
The employee is taxed on the economic benefit that he or she receives from the employer. This includes the term insurance cost of the death benefit provided. The excess cash value is also taxed to the employee as it accrues rather than not being taxed until the employee withdraws the money as was the case prior to Notice 2002-8.
In this case, the employee owns the policy with premiums being paid by the employer. As stated in the name, the employee collaterally assigns the policy to the employer as security for the premiums paid by the employer.
The net death benefit is payable to the beneficiary when the insured dies. The employee is entitled to the cash value in excess of the premiums paid by the employer.
Premiumd paid by the employer are loans to the employee. In the past, employers made interest-free loans to the employee, but, under 2003 split-dollar regulations, the employer must charge a market interest rate or the employer must impute interest at the applicable federal rate to the employee even if they are not required to pay it.
FICA taxes will apply to either of these arrangements. Under the Section 409A rules, in order to receive tax deferral, plans must comply with restrictions on timing of elective deferrals and distributions (like deferred-compensation plans).
Split-dollar arrangements do not provide the tax advantages they formerly did, but using a loan arrangement in the proper circumstances may still provide benefits if finding premium dollars are an issue (and when are they not an issue). I would rather borrow money for premiums from my closely-held company than from a premium finance company.
Written by Robert W. Schefft, JD, CFP, Vice President, Advanced Sales and Marketing of ANICO.