What is Split-dollar Life Insurance?

Split-dollar life insurance is a financial arrangement that allows an employer and an employee to share the costs and benefits of a life insurance policy. This strategy is commonly used to retain key employees, fund buy-sell agreements, and provide valuable financial security. Typically, these agreements involve permanent life insurance policies that include a cash value component.

How Split-Dollar Life Insurance Works

In a split-dollar agreement, the employer typically pays a portion of the premium, usually the amount that contributes to the policy’s cash value, while the employee covers the remaining balance. This structure ensures that both parties benefit from the policy. Upon the employee’s death, the employer is reimbursed for the premiums it pays, while the employee’s designated beneficiary receives the remaining death benefit.

This arrangement offers flexibility and can be customized to align with business goals, whether to attract and retain top talent or to provide structured financial benefits to executives and co-owners.

Types of Split-Dollar Life Insurance Agreements

Split-dollar life insurance arrangements vary in complexity and purpose. Below are some of the most common structures:

1. Employer-Employee Agreement

Employers use this model to offer an additional benefit to high-performing employees. The company pays a portion of the premiums, helping employees secure life insurance coverage they might not otherwise afford.

2. Co-Owner or Partnership Agreement

Business partners may utilize split-dollar insurance to fund buy-sell agreements, ensuring that if one partner passes away, the remaining partner has the funds needed to buy out the deceased’s share of the business.

3. Key Person Retention Tool

Companies often use split-dollar agreements to incentivize and retain key employees by offering an attractive benefit that aligns their financial well-being with the company’s long-term success.

4. Estate Planning Strategy

High-net-worth individuals and business owners use split-dollar life insurance for estate planning purposes. By structuring the agreement properly, they can ensure tax-efficient wealth transfer to their heirs while securing liquidity for estate settlement.

Tax Considerations of Split-Dollar Life Insurance

Understanding the tax implications of split-dollar agreements is crucial for compliance and financial efficiency. The IRS issued regulations in 2003 that guide taxation based on policy ownership.

• If the employee owns the policy, the employer’s premium payments are treated as loans to the employee, subject to interest and loan repayment terms.

• If the employer owns the policy, the premiums paid by the employer are considered taxable economic benefits to the employee, meaning the employee must report the value of the benefit as taxable income.

Neither the employer nor the employee can deduct the cost of premiums under a split-dollar arrangement. Employers cannot claim tax deductions since they are considered direct or indirect beneficiaries of the policy. Employees, on the other hand, must treat their premium payments as personal expenses, making them non-deductible.

Given the complexity of these tax rules, consulting a financial adviser or tax professional is essential to ensure compliance and optimize benefits.

Reverse Split-Dollar Life Insurance

A variation of traditional split-dollar agreements, reverse split-dollar life insurance, offers a different method for structuring employer-employee life insurance arrangements.

How Reverse Split-Dollar Works

In a reverse split-dollar arrangement, both the employer and employee contribute to premium payments, but the benefits are structured differently. Upon the employee’s death:

• The employee’s beneficiary receives a payout equivalent to the total amount of premiums paid by the employee over the policy’s lifetime, plus interest.

• The employer receives the remaining death benefit.

Why Employers Use Reverse Split-Dollar Insurance

Reverse split-dollar life insurance is frequently used as a form of key-person insurance, helping businesses recover from the financial impact of losing a key employee. This approach ensures that the company receives financial compensation to offset potential disruptions in operations, leadership, or revenue generation.

Tax Considerations for Reverse Split-Dollar Arrangements

Just like traditional split-dollar agreements, neither the employer nor the employee can deduct the cost of premiums under a reverse split-dollar plan. This means:

• Employers cannot claim tax deductions because they benefit financially from the policy.

• Employees must account for their premium contributions as personal expenses.

Is Split-Dollar Life Insurance Right for You?

Split-dollar life insurance provides a strategic financial tool for businesses and key employees, offering a cost-effective way to provide life insurance coverage while meeting business objectives. However, these arrangements require careful planning and legal structuring to align with tax laws and financial goals.

Before implementing a split-dollar plan, business owners and employees should consult with financial advisers, tax professionals, and legal experts to determine the best approach for their specific needs.

Whether used for employee retention, business succession planning, or estate management, split-dollar life insurance can be a powerful financial tool when structured correctly. Give us a call today at 909.466.7876 for more tips and guidance on what employee benefits to offer.

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