Split-Dollar Life Insurance: What It Is and How It Works (2024)

Separate your company from competitors by utilizing split dollar life insurance as a component of compensation for your key employees.

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Scott Karstens is a writer and accomplished insurance and financial services veteran. He’s the president of NFG Brokerage and founder and CEO of both Broker Backoffice and his new direct-to-consumer insurance platform, Quote Bot.

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Tori Addison is an editor who has worked in the digital marketing industry for over five years. Her experience includes communications and marketing work in the nonprofit, governmental and academic sectors. A journalist by trade, she started her career covering politics and news in New York’s Hudson Valley. Her work included coverage of local and state budgets, federal financial regulations and health care legislation.

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A split-dollar life insurance arrangement is a planning tool that can be used to provide benefits for both an employer and its employees. It involves the sharing of premiums and death benefits related to a life insurance policy taken on the employee.

Split-dollar arrangements are often used as part of executive compensation packages, helping employers attract and retain key personnel. Split-dollar life insurance may also provide personal financial protection for individuals by allowing them to build up their own cash value within the policy or to help them afford the life insurance protection they need.

With such a wide range of possible advantages, split-dollar life insurance can be an effective way for businesses and individuals alike to plan ahead financially.

What Is Split-Dollar Life Insurance?

Split-dollar life insurance is an agreement where two parties — an employer and an employee — agree to split the benefits, and sometimes the costs, of a life insurance policy. The employer pays the life insurance premium, in whole or in part, on a cash value life insurance policy purchased on the life of the employee. It’s a common part of a C-suite’s executive compensation package.

Often in these arrangements, the employer retains the rights to the cash value and the death benefit up to the premiums paid by the employer. Sometimes, the employer earmarks an amount greater than the premiums paid.

In some split-dollar arrangements, the employee has rights to any cash surrender value in excess of the employer’s contribution to the plan. If the employee pays into the plan, the employee’s beneficiaries may be entitled to an amount that’s proportionate to the employee’s premium payments.

Advantages for the employer:

1. The death benefit is specialized for each agreement.
2. The business can plan its premium contribution for each agreement.
3. The employer can control the flow of the cash value and death benefit you own.
4. The business has significant flexibility in nearly every portion of the plan design.
5. If the business is a C corporation, it may use the cash value to which it’s entitled for corporate needs.

Advantages for the employee:

1. You may use your portion of the death benefit for your personal use.
2. You can accumulate cash value more quickly due to the employer’s contribution.
3. Your beneficiaries receive a tax-free death benefit.

How Split-Dollar Life Insurance Works

Split-dollar life insurance begins with an agreement. The following steps pertain specifically to corporate split-dollar agreements rather than private split-dollar agreements.

In a corporate split-dollar agreement, an employer and the employee are sharing the costs and benefits of a life insurance policy for whom the employee is the insured person. The agreement will describe how the death benefit is divided between each party, how each party can access cash (if applicable) and how each party can exit the agreement.

Final regulations provide two types of split-dollar life insurance arrangements: economic benefit regimes and loan regimes. Under the economic benefit regime, the employer owns the life insurance policy but allows the employee certain rights, such as the right to name beneficiaries. Under a loan regime, the employee owns the policy and awards an interest in the policy to the employer. The taxation of the arrangement depends on which regime is chosen.

Here’s how a split-dollar life insurance arrangement under the economic benefit regime might be created.

1. Employer drafts a split-dollar agreement.
2. Employee signs a notice and consent for the life insurance being purchased and signs the life insurance application as the insured person.
3. Employer signs as the owner and payor of the life insurance policy and submits an application for life insurance on the life of the employee to the insurance company. Employer also sends along a split-dollar agreement.
4. Employee completes a medical exam to qualify, unless it’s a no-exam life insurance policy.
5. Once the life insurance policy is approved, Employee and Employer sign the split-dollar agreement.
6. Employer and Employee pay the premiums pursuant to their agreement.
7. Employer reports premiums by the Employer for coverage exceeding $50,000 as compensation on Employee’s Form W-2, Wage and Tax Statement.
8. Employer files Form 8925, Report of Employer-OwnedLife Insurance Contracts, each year.
9. Employer or a third party administrator tracks any change or fluctuation in benefit to Employee for tax purposes.

Example of a Split-Dollar Agreement

ABC Corp. and its executive enter a split-dollar agreement using the economic benefit regime. The policy provides a $1 million life insurance death benefit on the executive’s life. In their agreement, ABC Corp. owns the policy and, upon the termination of the agreement, is entitled to the greater of premiums advanced or the policy’s cash value. The executive (and whomever the executive names as a beneficiary) is entitled to death benefits paid under the policy in excess of the amounts owed to ABC Corp.

ABC Corp. reserves the right to use $500,000 of the policy’s death benefit for key person coverage. ABC also retains the right to all cash value as collateral for its contribution. The remaining $500,000 in death benefits is available for the executive to choose a beneficiary or beneficiaries.

Benefits of Split-Dollar Life Insurance Plans

Split-dollar life insurance arrangements seek to benefit both the employer and the employee.

First, the employer is allowed to individualize the agreement for each person covered, and the business receives the cash value and death benefit based on its contribution. It may also negotiate more favorable terms. This agreement lowers the cost, and possibly the tax burden, of providing an insurance benefit to the employee.

Also, the employee receives a death benefit at a discount or more cash value growth due to employer contributions.

Tax Benefits

In general, a corporation can’t claim a tax deduction for premiums payment provided for a split-dollar agreement. However, if the employer chooses to provide cash value to the employee at a future date, the employer can then take a deduction for the compensation to the employee.

Under the economic benefit regime, the employee pays a tax for the benefit they are able to control. Under the loan regime, premium payments by the employer are treated as a loan to the employee. In this agreement, the employee would pay tax on the interest for this loan.

Low Interest Rates

In the loan regime for split-dollar agreements, the employer is required to charge interest on the loan to the employee. Most often, the applicable federal rate (AFR) is used when calculating the interest for these loans. This rate is the minimum rate the employer can charge for a bona fide loan and is typically below market value interest rates.

Implications of Split-Dollar Plans

As an employee, when you enter into a split-dollar agreement, you are allowing life insurance to be owned on your life, directly (in an economic benefit arrangement) or through collateral assignment (in a loan arrangement), in exchange for what can often be favorable out-of-pocket expenses compared to buying a life insurance policy on your own.

Employers need to make sure they have the resources to keep up with the economic benefit calculations and make sure that loan terms and rates are up-to-date for each premium payment. Perhaps the most overlooked item is having the proper notice and consent from the employee on file and making sure the company files Form 8925 each year. Working with an experienced tax professional can be extremely valuable in navigating these complexities.

Types of Split-Dollar Life Insurance Policies

Final regulations published by the IRS and U.S. Treasury Department allow for two types of split-dollar life insurance arrangements.

Economic Benefit Regime

In an economic benefit arrangement, an employer owns and pays for the life insurance premium and will be the beneficiary of the policy up to some amount, which may be the greater of the employer’s contribution to the life insurance policy and a stated benefit needed for corporate planning.

The employee will name beneficiaries on the death benefit assigned to the employee. This assignment of death benefit provides a benefit to the employee similar to term insurance.

While the employee does not own or control the policy, the employee still receives value. This value is calculated each year based on the age of the employee and the death benefit available for the employee to assign to beneficiaries. The IRS provides a table of one-year term costs to calculate the economic value of death benefit available, which determines the taxability of the plan.

Loan Regime

Under a loan arrangement, the employee is the policy owner, and the employer generally pays the premium.

To ensure the employer is made whole, the employee grants an interest in the cash value and death benefit of the policy back to the employer through a collateral assignment. This assignment places restrictions on the policy, safeguarding the interests of both parties. For example, the employer may recover the loaned premiums to the employee if the employee were to unexpectedly pass away. This also makes it possible for the employer to recover their loaned premiums if the employee is no longer employed by the employer or at the termination of the agreement.

The premium payments made by the employer are treated as loans to the employee. Each year, these premium payments are considered as separate loans, allowing for flexibility in structuring them as either term or demand loans.

Moreover, these loans must be provided at an interest rate that complies with the applicable federal rate (AFR). The good news is that these loan rates will stay constant for each premium payment, so even though the interest rate can change each year, you will have known interest rates for each premium payment.

Determining If Split-Dollar Life Insurance Is Right for You

As an employer, a split-dollar plan provides you with a greater degree of benefits planning, while also providing ownership and control of the benefits. These agreements are very advantageous when looking to attract and retain key employees.

Before deciding if a split-dollar life insurance plan is right for you, it’s important to consider the benefits and implications of such an agreement.

Implementing Split-Dollar Life Insurance

To implement a split-dollar plan, you will need a split-dollar agreement. You may be able to find sample documents for these types of plans online, but for the complexity involved in these agreements it’s necessary to seek legal and tax advice.

Once you have this agreement, you will need to apply for life insurance for your employee, and they will need to qualify for life insurance. Once the plan is in place, you will need to do an annual review of the benefits to make sure you are properly accounting for the structure of the agreement in place.

How Split-Dollar Policies Are Terminated

Split-dollar plans are terminated at the earlier of the employee’s death or the termination date included in the agreement (often retirement or a benchmark of employment). There are three common ways that plans are terminated:

1. The employee dies. If an employee were to pass away unexpectedly while the agreement is still active, the employer recovers either the premiums paid, cash value or the amount owed in loans per the agreement. Then, the employee’s named beneficiaries receive the remainder as a tax-free death benefit.
2. The agreement terms end. If the employee completes the terms of the agreement in a loan regime agreement, all collateralized restrictions are released under the loan arrangement. In an economic benefit plan, the ownership of the policy may also be transferred to the employee as an added benefit. In either of these circumstances, this event would generate taxable income to the employee, which may be deductible by the employer.
3. One party chooses to terminate. An employer could choose to exit the plan at the termination of the agreement, and the employer may recover all or a portion of the premiums paid or cash value. The employee then would own the insurance policy. The value of the policy is taxed to the employee as income tax and is potentially deductible for the employer.

Is Split-Dollar Life Insurance Worth It?

A split-dollar plan is a valuable, non-qualified plan that can provide significant benefits to all parties when structured properly. An employer can provide additional benefits to key employees and an employee can benefit from the employer’s contribution to premium payments . Consider working with a knowledgeable insurance agent and a financial advisor when putting these plans in place.