What is split dollar life insurance?

When you work for an organization, it’s important to look into the employee benefits and incentives that are offered to you. While there’s a long list of different benefits that can be offered, one of the most beneficial to employees who are planning for the future is split dollar life insurance. Most believe that only executives can be so lucky as to be rewarded with low-cost key man life insurance. With the proper benefits plans in place, split dollar insurance plans are a way to provide employees at all levels on the corporate ladder with low-cost life insurance for estate planning purposes. Compare life insurance rates now by using our FREE comparison tool above!

It’s easy to assume that when a company offers specialized life insurance plans to their workforce that it’s a benefit that’s only beneficial to the insured. From the outside looking in, this may be how it appears, but you’ll need to understand the workings of split dollar insurance to really see the big picture. There are advantages to the employee, but there’s a long list of advantages to the employer as well. Find out more about the split-dollar life insurance arrangement, how it’s structured, and even the tax implications by reading this consumer guide.

What is the split-dollar life insurance arrangement?

A split dollar life insurance plan is purchased when an employer and an employee have a special arrangement so that each party share both the costs and the benefits of a life insurance policy on the employee. In some other scenarios, the arrangement can be used in the estate planning process between adult children and their parents.

While some might assume it’s a particular type of insurance, it’s actually a technique of ownership sharing.

The arrangement can work in a number of different ways depending on how the agreement is written up. The gist is that one party will purchase some form of cash value insurance on the life of the other so that one receives discounted premiums and the other receives tax advantages while still securing deferred compensation once it’s time for a policy payout.

Each party pays a portion of the premiums and then will agree to how and what will be split in the long run. The following can be shared or split based on how agreements are constructed:

• Death benefits
• Cash values
• Ownership
• Dividends
• Surrender values

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What is the purpose of the arrangement?

When the split-dollar arrangement’s used in the employer-employee scenario, the purpose is to provide the employee with a low-cost policy so that the organization can offer their employees with a competitive compensation package. While attracting candidates and motivating current employees to perform may be two great reasons that organizations offer this incentive, the main reason is to fund certain types of deferred compensation plans and severance benefits without having to use non-qualified insurance-funded plans that have no tax advantages.

If the split-dollar arrangement is being used by families in wealth and financial planning, the purpose is very different. The private arrangement in this arena is used for gifting purposes so that families can reduce their tax obligations and transfer policy ownership to another party so that they’ll enjoy the economic benefit of the insurance without having to worry about taxes or other implications that could arise.

Family split-dollar arrangements will involve a cash value policy an irrevocable trust, an insured and a policy owner (trustee). It’s essentially a tax-friendly way to gift permanent life insurance to the estate so that there’s no need to make taxable gifts and apply for a Generation Skipping Trust tax exemption.

How is business split-dollar life structured?

Now, it’s time to take a look at how your arrangements can be structured between employers and employees in the business arena. There are two different types of structures that you’ll need to be familiar with if your goal is to be well-versed in all things split dollar life. The two structures you’ll run into are: Endorsement Method and Collateral Assignment Method.

• Endorsement Method

When you enter an endorsement arrangement with an employer, the employer will be the owner of your life policy and will pay the premiums of the policy directly. Since the employer is taking on the expense of paying for the premiums, they will receive some of the death benefits or the cash surrender value of the policy when paid.

In most cases, employers will receive proceeds in the amount of what cash values are present on the policy at the time of the insured’s death.

To ensure that they get their money back, the employer will be both the owner of the life policy and also the first-named beneficiary. Any beneficiary that the employee chooses to name to receive benefits from the face value of the policy will be secondary to the employer. In layman’s terms, this means that loved ones are paid second and the employee is not a shareholder with direct interest in the policy.

Endorsement methods can create tax consequences to the employee because the premiums are non-deductible and must be reported for income tax purposes. Since the employee is not an owner on the policy, it cannot be taxed in the estate or included in the gross estate.

• Collateral Assignment Method

A collateral assignment arrangement is when the employee owns their own policy and the employer holds the policy as collateral so that they can pay the policy premiums. To assign the employer, the employee must sign an assignment form that will state how much of the premiums the corporation is responsible for. It will also state what the employer will receive at the time of death or at the time the policy is surrendered.

In most cases, the employer will receive the total amount of premiums they paid into the policy and the remainder would then go to secondary beneficiaries. In some cases, there may be other portions of the policy shared or split. Since the employee is the owner of the policy, the payout is not included in the estate and the premiums do not need to be included in income tax filings.

Difference Between Group Life and Split-Life Arrangements

Perhaps the biggest difference between group life insurance and split-life arrangements is that group life is a type of insurance and split-life arrangements are funding techniques. Since both are terms in the life industry used when employers offer incentives, they can be mistaken for one another. In actuality, they are two different terms that describe different types of benefits.

• Group Life Characteristics

Group life insurance is a product available through life insurers who offer specialized rates to larger pools of insureds who work for corporations. Employees can only buy insurance through the company that the employer is doing business in and will more than likely only be offered term insurance.

Since it is a special sector, companies cannot deny anyone with a medical condition.

Group policies have lower premiums because the company agrees to buy policies in bulk for their employees through pre-taxed dollars. Since they are discounted rates, the employee can buy low-cost insurance but the policy cancels once the employee leaves, is terminated or retires.

• Split-life Agreement Characteristics

Split-life is simply an agreement that is put into place when an individual policy is taken out. You can purchase any type of cash value policy which might include: whole life, universal life, variable life, and second-to-die insurance. Since it is a standard policy with assignment forms and endorsements, you do not to be in good health to qualify for coverage. You also will not receive bulk discounts but will have a smaller financial obligation because your employer is paying all or some of the pure life premiums.

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Advantages to Employees

• Purchase low-cost permanent life insurance using the employer’s money
• Get peace of mind now if you cannot afford high premiums for cash value coverage
• Customize the plan to meet your own estate planning objectives
• Death benefit to the named beneficiaries will typically be tax-free
• If employer pays premiums it can lower the employee’s tax bracket

Advantages to Employers

• Providing low-cost employee benefits to the workforce for higher satisfaction
• Attract better candidates and build a stronger workforce that wants to perform
• Keep employees motivated and keep employee retention rates extremely high
• The portion of premiums that the employer pays are tax deductible
• All premiums paid into the policy will be returned upon the employee’s death so there is little to no risk involved

As you can see, it’s very possible that a split dollar insurance plan can be used as a key technique for building comprehensive compensation plans.

There are so many different types of life policies available through many different insurers. If you’re interested in pricing costs so that you can see just how much the corporation is agreeing to pay, do a price comparison. By using an online comparison tool, you’ll easily be able to see how much you’re saving in out-of-pocket cost. Start comparing life insurance rates now by entering your zip code in our FREE tool below!

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