How Split Dollar works
The term "Split-Dollar" is derived from the fact that the premiums for the life insurance policy on an employee are split between the insured employee and his or her employer. In the most traditional form of split-dollar, the employer pays the portion of the premium that relates to the yearly build-up in the cash value, while the employee pays the portion that relates to the term (pure insurance) protection.
Fortunately, basic Split Dollar arrangements are easy to set up, easy to understand, and easy to administer. The life insurance policy can be owned either by your business (Endorsement Split Dollar) or by the employee (Collateral Assignment Split Dollar). Whichever choice is made, the business will own all of the cash value of the policy at all times. This cash value can be accessed directly if the business is the owner of the policy, or through a collateral assignment form if the employee is the policyowner. A third party, such as the employee’s irrevocable life insurance trust, can also own the policy.
Under the Split Dollar arrangement, upon the employee’s death, your business will receive a portion of the death benefit equal to the greater of the premiums paid or the cash value of the policy just before the employee’s death. The employee’s beneficiary will receive the remainder of the death proceeds.
Improving the basic, simple plan
Split Dollar by itself is great if the employee dies while the plan is still in effect, but what happens at retirement? Your business can create a supplemental executive retirement plan (SERP), using your business’ interest in the life insurance cash values to fund the promised benefits. Withdrawals can be taken from the policy to distribute to the employee, or the entire policy can be transferred to the employee in a lump sum at retirement. As a form of “Golden Handcuffs,” the promised benefit to the employee can be made contingent upon the employee fulfilling certain requirements, such as remaining employed for at least ten years.
Tax consequences
In exchange for the employee’s beneficiaries receiving an income tax free death benefit from the life insurance policy paid for by your business, the employee is required to include in income the economic value of the current year’s death benefit protection each year that the Split Dollar arrangement remains in effect. This value is calculated based upon the employee’s age using either the Internal Revenue Service (IRS) Table 2001 rates or the insurance company’s alternative qualifying term insurance rates.
At the employee’s retirement, the employee will be taxed on the value transferred from your business under the SERP arrangement. The business receives a deduction equal to the amount of compensation reportable by the employee. The business’ tax savings could be used to gross-up the employee’s compensation sufficient to cover the employee’s taxes on the distribution of the policy. Note that any promise, understanding or agreement by the employer to provide compensation (including a tax gross-up) at retirement or at any time in the future constitutes Deferred Compensation within the definition of section 409A of the Internal Revenue Code. Any such arrangement must be fully compliant with the requirements of the IRC 409A.
Summary of employer advantages
• Employee Loyalty
• Selectivity
• Low Cost – Cost Recovery
• Disability Protection with Waiver of Premium Rider
• Employer Control of Policy
• Documented plan eliminates question of whether future salary continuation represents reasonable compensation
Please contact us for more information today