The Operation of Split-Dollar Life Insurance
One approach that permits the cost of a permanent life insurance policy premium to be shared is split-dollar life insurance. They may benefit both the firm and the individual and are frequently a significant component of an executive remuneration package.
Split-Dollar Life Insurance: What Is It?
An employer and employee sign a formal agreement outlining how they would split the cost of the policy’s premiums, cash value, and death benefit under a split-dollar plan. Employers commonly utilize split-dollar plans to help retain important personnel and offer leaders additional rewards.
The agreement specifies the goals of the employee, the duration of the plan, and the termination procedure. It also contains clauses that limit or terminate benefits in the event that an employee quits or doesn’t meet predetermined performance standards.
Additionally, split-dollar plans need yearly tax filing and record-keeping. With a few exceptions, the insurance owner is often also the owner for tax reasons. Employer-provided premiums are regarded as taxable benefits for the executive.
The utility of split-dollar plans is further limited by the firm’s form (e.g., as a S Corporation, C Corporation, etc.) and whether or not plan members are also business owners.
Advantages of Divided-Dollar Plans
For many years, split-dollar plans have been in use. New IRS regulations outlining two eligible split-dollar arrangements—economic benefit and loan—were issued in 2003. Even if some tax benefits were eliminated that year, split-dollar plans still have perks like:
Paying for personal life insurance with company funds: Plans may be able to leverage the advantage, particularly if the company is in a lower tax band than the employee.
Low interest rates: When the plan is put into effect, low interest rates are available if the relevant federal rate (AFR) is lower than the going market interest rates. Even if interest rates increase in the future, loan-backed plans can keep the interest rate in place at the time of adoption.
Arrangement for Financial Gains
Under the economic benefit arrangement, sometimes referred to as the economic benefit regime, the employer owns the insurance, pays the premium, and gives the employee certain rights or benefits. Employee-selected beneficiaries may get a portion of the insurance death benefit. The financial benefit that the employee receives is valued annually.
Arrangement for a Loan
The economic benefit plan is simpler than the loan arrangement, or loan regime. The policy is owned by the employee under the loan arrangement, and the employer covers the premium.
Through a collateral assignment, the employee returns an interest in the policy to the employer. The policy is restricted by a collateral assignment, which limits the employee’s actions without the employer’s approval. The employer would normally be able to recoup the loans given in the event of the employee’s death or the agreement’s termination.
The employer’s premium payments are seen as a debt to the worker. The premium payment is technically considered a separate loan each year. Loans must have a suitable interest rate depending on the AFR and can be either term or demand structured.
Putting an end to split-dollar plans
Split-dollar plans end when the employee passes away or at a later period specified in the contract, usually retirement.
Depending on the agreement, the employer may get the cash value, the amount owing on loans, or the premiums paid in the event of the employee’s untimely death. The remaining amount is paid as a tax-free death benefit to the employee’s designated beneficiaries, who may include an ILIT, if the company releases any policy limitations upon return.
All limitations are lifted under the loan arrangement or ownership of the insurance is passed to the employee under the economic benefit arrangement if the employee complies with the terms and conditions of the agreement.
The employer may be able to recoup all or a portion of the cash value or premiums paid, depending on how the agreement was written. The insurance coverage would then belong to the employee. The employee receives remuneration in the form of taxes on the policy’s value and employer-paid premiums.
A split-dollar policy is owned by whom?
A split-dollar policy’s owner is dependent on the agreement. The insurance is owned by the employee and the premium is paid by the company under a “loan” arrangement. The employer owns the insurance, covers the premium, and grants the employee specific rights or advantages under a “economic benefit” arrangement.