Dana George has a BA in Management and Organization Development from Spring Arbor University. For more than 25 years, she has written and reported on business and finance, and she's still passionate about her work. Dana and her husband recently moved to Champaign, Illinois, home of the Fighting Illini. And though she finds the color orange unflattering on most people, she thinks they'll enjoy Champaign tremendously.
Our Insurance Expert
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When a company makes a job offer, it often discusses life insurance options as part of the benefits package. And when it's a high-value employee, the options available often include split-dollar life insurance. Here, we'll tell you what split-dollar life insurance is, how it works, and how it benefits both employer and employee.
Split-dollar life insurance policies are designed to recruit and retain high-value employees. There are two primary types of split-dollar life insurance agreements. Here, we'll tell you how this type of policy works and how each party benefits from the arrangement.
Split-dollar life insurance is not a type of policy. Rather, it's an agreement between an employer and an individual. Here's how it works:
At first glance, split-dollar life insurance may seem confusing, but it's really not. There's only one thing to remember: Split-dollar life represents an agreement between two parties, and every detail stems from that agreement.
For example, which party owns a split-dollar life insurance policy depends on the type of agreement that was made.
With an economic benefit arrangement, the employer owns the policy and pays the premiums. However, the employer allows the employee to choose the life insurance beneficiaries. If the employee dies, the employer ensures that beneficiaries receive a portion of the policy's face value.
Although the employee does not own the policy, they are responsible for paying income taxes on the benefit received. Depending on how the agreement is written, when the employee leaves the company, the policy may be transferred to them, or they can purchase it.
When an agreement calls for collateral assignment, the employee owns the policy. The employer treats the funds they pay toward premiums as a loan to the employee. If the employee leaves, the loan may be forgiven or the employee may be expected to repay the money, depending on how the agreement was written. What happens to any cash value that has built up also depends on the initial agreement.
While the employee is taxed on the interest-free portion of the loan, the employer receives a tax deduction.
When a company offers its employees term life insurance, it's pretty cut and dried. It purchases a policy for a specific amount and pays the premiums. With a split-dollar plan, the company not only purchases a permanent life policy, but it also tailors an agreement with the employee that will benefit all parties involved. And the benefits associated with a split-dollar plan can be plentiful.
Split-dollar life insurance is a nice perk for employees. Here are some of the reasons why:
Employers understand that they must compete for top-notch talent. Including split-dollar life insurance in a compensation package benefits the employer in five ways:
While split-dollar life insurance has historically been an agreement between an employer and employee, it can also be used for estate planning. An intergenerational split-dollar plan involves an irrevocable life insurance trust (ILIT) "owning" a life insurance policy on a specific member of a family. Premiums are (at least partially) paid by the trust, and proceeds are divided based on how the agreement is written.
Using a split-dollar insurance policy as part of estate planning is intended to reduce the amount of estate taxes due following the death of the insured.
How a split-dollar insurance plan is terminated depends on how the original agreement is written. Typically, it ends when an employee dies, retires, or leaves the company. As long as it's part of the original agreement, the employee may be able to take their permanent life insurance plan with them. For someone who prefers permanent life to term life insurance, split-dollar life insurance is a valuable perk.
The employer pays the premiums for both types of plans: Economic benefit arrangement and collateral assignment. The difference is, when the two parties agree on a collateral assignment plan, the employer treats the premiums paid toward the policy as a loan to the employee.
Because the employer either pays the premiums directly or through a loan arrangement with the employee, the employee receives an economic benefit. The value of that benefit is taxed as income.
Yes, a split-dollar life insurance arrangement is a fringe benefit, typically offered to high-value employees. While it's designed to attract top-notch employees, a split-dollar life insurance policy also benefits the company in the event of the employee's death.
A reverse split-dollar policy is owned by the employee, but the employer pays the costs. Typically, the company names itself as the beneficiary, and the two parties agree that the company will receive a specific amount of money if the employee dies. The employee names their own beneficiary who receives what's left of the death benefit once the company claims their portion.
The two basic types of split-dollar plans are: An economic benefit split-dollar arrangement, in which the employer owns the policy, and a collateral split-dollar assignment, in which the employee owns the policy.