Split dollar life insurance is a strategy that employers often use to offer life insurance to their employees. While it is most often used in a business setting, it can also be used between two individuals. Split dollar life insurance is not an insurance product offered by companies, but instead is an agreement between two parties about how to use and pay for a life insurance product.
The split dollar life insurance strategy is used most often between employers and their employees. It can be offered as a benefit with certain jobs, although this is not as common now as it used to be. Split dollar life insurance is also sometimes used in estate planning between two private parties. This strategy is not as common now as it was in the past, but it still has some benefits. Here’s everything you need to know about split dollar life insurance.
How Does Split Dollar Life Insurance Work?
Split dollar life insurance essentially serves as an agreement between two parties about how they will share both the premium costs of the life insurance policy and the benefits. There are many different ways that these agreements can work, but the agreement will need to outline who owns the policy, how the policy will be paid for, and how the payments are made. The IRS imposed new regulations on split dollar life insurance in 2003, which limited some of the tax benefits associated with them.
What Kind of Split Dollar Life Insurance Agreements Are There?
There are two different ways that split dollar agreements can work between employees and their employers. These are the economic benefit arrangement or the loan arrangement, as defined by the IRS.
Economic Benefit Arrangement: This is sometimes called an endorsement agreement. In this scenario, your employer owns the life insurance policy. You’ll then be able to designate who you would like to receive the benefits, whether that’s yourself or someone else in your life. The employer also pays the premiums in this scenario. For tax purposes, the employee is the one responsible for paying taxes on the benefit. The company will calculate the amount of economic benefit the employee is receiving per year with the split dollar agreement, which they will then use for tax purposes.
Loan Arrangement: The other option for employee-employer split dollar life insurance agreements is the loan arrangement, which is sometimes referred to as collateral assignment. In this scenario, the employee is the owner of the insurance policy and makes the premium payments. However, their employer is assigned a portion of the death benefit and may loan the employee money to make premium payments. This is because their portion of the death benefit serves as collateral. When the employee dies, the employer collects their portion of the life insurance. If you are an integral part of your company’s operations, this arrangement ensures that they don’t take a financial loss because of your passing. Since you own the policy, you will need to pay taxes on the ‘loans’ that your employer provides for you to pay your insurance premiums.
Private Split Dollar Life Insurance: Some people choose to use split dollar life insurance plans as part of their estate planning. Since estate taxes only apply to the very wealthy, this strategy is used very rarely. Typically, the split dollar agreement will involve an irrevocable life insurance trust. This puts the life insurance plan into a trust, essentially protecting the life insurance plan from estate taxes.
Benefits of Split Dollar Life Insurance
If your employer offers it, there are many benefits to using split dollar life insurance as an employee. The biggest benefit is that regardless of what arrangement you use, you will not have to pay your own premiums – you will only have to pay taxes on either your calculated economic benefit or the amount that your employer is loaning you to pay for the policy.
In this scenario, employees may also get access to the life insurance policy’s cash value. Permanent life insurance policies, like whole life or universal life, typically come with a cash value benefit. This may be accessible to you after the policy has been in place for a certain period of time, although in some cases you may have to repay the amount that you borrow from your insurance policy.
There are particular tax benefits for those who run their own corporations. This is one of the only ways that you can use your company’s money to pay for life insurance coverage. Depending on the tax bracket both you and your corporation are in, you may save money in the long run by doing it this way. This also ensures that the corporation isn’t struggling financially if you pass away.
Of course, there are also tax advantages here for those looking to avoid estate taxes. A split dollar life insurance plan helps the wealthy protect their life insurance plan from taxes, so they can pass on more money for their families.
Managing Split Dollar Life Insurance
Split dollar life insurance can be very complicated, particularly when it comes to their tax ramifications. Because of this, many people don’t use split dollar life insurance anymore. If your employer offers split dollar life insurance as a benefit, it’s very important to talk to a tax professional before finalizing the policy. Since split dollar life insurance benefits are taxed differently, you will likely need ongoing guidance to ensure that you are adhering to the IRS’s tax rules.
If your employer offers split dollar life insurance, it’s worth considering – but you may also want to take out your own personal life insurance plan as well. You’ll need to thoroughly assess the benefits and costs of a split dollar life insurance agreement and make sure that it is still providing you with the coverage you need. Ultimately, it never hurts to have extra insurance coverage, and a split dollar life insurance plan can be a good supplement to what you already have.
