Split-dollar life insurance policies are a payout method for life insurance policies, whether cash or other benefits, will be divvied up between multiple parties. The policy add-on, though not the most popular, is useful in workplaces where a high-level executive or key party in business requires life insurance.
Table of Contents
Understanding Split-Dollar Insurance Plans
Split-dollar insurance isn’t a type of life insurance in and of itself but rather a payout method that helps both a key employee’s beneficiaries and their employer. Typically, this payout method is in conjunction with whole or permanent insurance plans and can be used as an enticement for employees by employers.
As for the employer’s interest in the policy add-on, the split-dollar plan will help employers in the case of carrying on with business after a key player dies. Split-dollar insurance is great for retaining important employees within a company’s rankings.
While savvy companies may apply the benefit to a wider set of employees, other corporations will reserve the add-on benefit for the highest executives within a model. These plans have been around for decades and come in two models as approved by the IRS, economic benefits or loans.
Two Types of Split-Dollar Insurance
Economic benefits are the first type of split-dollar insurance plan and usually occur when the employer is paying for the life insurance policy. The employee’s beneficiaries will still receive a portion of the plan’s benefit, but so will the employer. The tradeoff is that the benefit will be split upon death. Additionally, economic benefit split-dollar insurance plans are taxed as employment income in which taxes will be figured annually.
On the other hand, the loan split-dollar insurance type, also lumped with a collateral assignment, is when the employee will own the policy, and the employer will pay the premium. The employer will earn a portion of the benefit if the employee were to die, but at the core, the employee owns the plan. Contrary to the economic benefit policy, the IRS will treat this division as a loan that is interest-free and payable to the employee, with the employee paying taxes on the interest. If the employee passes away, the benefit amount paid to the employer would be considered repayment for the loan.
What Are the Benefits of Split-Dollar Insurance?
There are multiple benefits that make a split-dollar insurance plan especially enticing, but that’s not to say that it is necessary for every scenario. Depending on the agreement made by the employer and employee, benefits may include premium payments by the employer rather than the employee themselves, interest rates that are lower than market value that benefit the corporation or employee directly, especially for a plan that highlights a loan as original rates are maintained over time.
The employer will also benefit from a reduced financial obligation if a key employee dies, which can help them find a replacement. Additionally, employees won’t need to invest hours into research on life insurance quotes if they don’t want to, though it may be helpful to understand all options as the employer-sponsored plan is not a requirement.
How Does Split-Dollar Insurance Work?
When a split-dollar payout plan is proposed, usually as part of a hiring package, all terms will need to be agreed upon by the employee and employer. Usually, the agreement will cover:
- premium costs
- payments by both or either party
- the cash value of the plan
- who owns the plan (employer, employee, business partner, trust)
Additional factors that will need to be agreed upon include the length of the plan’s coverage, what an employee needs to do to maintain the plan, and when the plan will expire, either in the case of death or at a pre-determined date in the future. Some split-dollar insurance plans are also directly tied to an employee’s performance, and measures may be set up ahead of time that needs to be met or the employee risks losing their benefits.
It is important that tax specialists and/or attorneys look over the contract thoroughly to ensure that all parties are properly cared for. It’s important for the employee to also make sure that split-dollar insurance plans are best for them both in terms and economic benefits. Being educated on the market, such as shopping around for personal life insurance quotes, is a great way to stay informed and advocate on one’s behalf.