Definition and Structure
Split Dollar Life Insurance is a policy arrangement where the premiums, ownership rights, and death proceeds are divided between two parties—typically an employer and an employee or a parent and a child. This arrangement is intended to provide life insurance benefits in a manner that can offer financial advantages to both parties involved.
Premium Payments
In a typical Split Dollar Life Insurance, the employer or the funding party pays at least the portion of the annual premiums that equals the increase in the cash value of the policy. In some cases, the employer may cover the entire premium. The contributions can vary based on the agreement terms established at the inception of the policy.
Ownership Rights and Death Proceeds
Ownership rights of the policy are divided between the parties involved. Upon the death of the insured, the death benefits are split according to the predefined agreement:
- Employee’s Beneficiary: A designated beneficiary chosen by the employee receives a portion of the death proceeds.
- Employer: The employer may receive a return of premiums paid or a specified portion of the death benefit.
Types of Split Dollar Life Insurance Arrangements
Endorsement Split Dollar
In this arrangement, the employer owns the policy and endorses a portion of the death benefit payable to the employee’s beneficiary. The employer retains control over the policy and is responsible for paying premiums.
Collateral Assignment Split Dollar
Here, the employee owns the policy and the employer’s interest is secured by collateral assignment. The employee assigns a portion of the policy’s cash value to the employer, ensuring repayment of premiums or a share of the death proceeds.
Special Considerations
Tax Implications
Split Dollar Life Insurance arrangements can have significant tax implications. Premium payments may be considered a taxable economic benefit to the employee, and the specifics depend on the types of agreement and the structuring of payments.
Regulatory Compliance
Ensuring compliance with the Applicable Federal Rate (AFR) and the various Internal Revenue Code (IRC) sections, particularly IRC 61, 83, and 7872, is crucial in structuring these policies to align with IRS guidelines.
Historical Context
Split Dollar Life Insurance gained prominence in the mid-20th century as a method for employers to provide life insurance benefits to key employees and executives while maintaining some financial leverage. Over time, structured properly, this setup became beneficial for both the funding party and the beneficiary.
Applicability and Use Cases
Primarily used in executive compensation and benefits planning, Split Dollar Life Insurance provides a financial incentive to the employee and financial leverage to the employer. It is also seen in family financial planning, especially with wealth transfer strategies between parents and children.
Comparisons with Other Insurance Policies
Split Dollar vs. Term Life Insurance
- Duration: Term Life covers a specific period, while Split Dollar can be permanent with investment components.
- Premium Payments: Term Life paid wholly by one party, while Split Dollar has shared premiums.
- Death Proceeds: Term Life proceeds go to a single beneficiary, whereas Split Dollar are split.
Split Dollar vs. Whole Life Insurance
- Premium Responsibility: Whole Life premiums paid by the policy owner in full, Split Dollar shared.
- Control and Ownership: Whole Life wholly owned by the policy buyer, while Split Dollar shared ownership.
Related Terms
- Key Person Insurance: Life insurance on a key employee where the employer receives death benefits to sustain business operations.
- Non-Qualified Deferred Compensation: A plan where an employee defers receiving part of their income until a later date.
FAQs
What happens to the policy if the employment relationship ends?
Are there any specific laws governing Split Dollar arrangements?
Can regional variations affect these policies?
References
- Internal Revenue Code (IRC) Sections 61, 83, 7872.
- Life Insurance and Employee Benefits Law (Employee Benefits Law, Third Edition).
Summary
Split Dollar Life Insurance offers a unique method for structuring life insurance benefits between two parties, balancing financial leverage and benefits. With applications primarily in executive compensation and family planning, it is essential to navigate the legal and tax intricacies to maximize the benefits of such arrangements.
