Split-dollar life insurance

Most people only need a personal life insurance policy to protect their loved ones in the event of their death. But some people, particularly business owners and executives, may also need a life insurance plan to protect against the impact their death would have on their business. 

Some businesses fill this need with split-dollar life insurance. Split-dollar isn’t a life insurance product, it’s a formal agreement between two or more parties to share the ownership and benefits of a permanent life insurance policy with a cash value component. Split-dollar contracts are most often used by companies to decrease the financial impact of losing a key executive (like a CEO) and/or as a benefit in executive compensation packages.

What is split-dollar life insurance?

Split-dollar life insurance is an agreement in which the payment and death benefit of a permanent insurance policy with a cash value is shared, usually between an employee and their employer. In business contexts, it’s often a form of company-owned life insurance that benefits both you and your employer.

Every split-dollar policy must involve two or more parties and divide the responsibilities and benefits of a cash value life insurance policy. But every split-dollar agreement can differ in:

• Who pays the premiums 

• Who owns the policy

• Who names the beneficiaries 

• How the death benefit and cash value is split 

• When and under what circumstances the agreement ends

All of these details should be laid out in the contract establishing your split-dollar life insurance policy.

Though it’s possible to employ a split-dollar agreement for a personal life insurance policy, it’s only useful to do so if you need to minimize your estate taxes, which most people won’t need to worry about.

Who is the owner of a split-dollar life insurance policy?

The ownership of split-dollar life insurance is determined by you and/or the other party involved in the agreement, though each ownership model comes with its own advantages and disadvantages. A split-dollar policy can be owned by:

• You: You can own a split-dollar policy while your employer (or another party) makes part or all of the payments.

• Your employer: Like key person insurance, your employer can own the policy and use their portion of the payout to recoup business expenses related to your passing.

• A business partner: Small business partners may include a split-dollar contract in their buy-sell agreement, which dictates what happens if one owner exits the business.

• A trust: Placing your life insurance policy in an irrevocable life insurance trust means it won’t be counted in the value of your estate.

• A family member: Assigning ownership of a permanent policy to a loved one is another method of minimizing future estate taxes.

Pros and cons of split-dollar life insurance

It’s less likely that you’ll see a split-dollar contract today, after changes in tax law in 2003 made the benefit less appealing for many businesses to offer. However, split-dollar life insurance still has some uses in small businesses and estate plans. Depending on your situation, these are the pros and cons of a split-dollar agreement:

Pros:

• Employer subsidizes the premiums for a costly permanent policy

• May help employers attract top talent if offered as a benefit

• Can shield your permanent policy from estate taxes

• Cash value may provide additional retirement savings

Cons:

• If you leave your employer you must give up your policy or pay the full premiums yourself 

• Cash value accounts generally have a low rate of return

• Can add complication to your taxes as an individual or as an employer

• Permanent policies are more expensive than term life insurance

Compare and buy life insurance

GET STARTED

How does split-dollar life insurance work for businesses and employees?

For businesses and employees, there are two main types of split-dollar life insurance agreement:

• Collateral assignment/loan regime: When you own a split-dollar policy but your employer pays the premiums, you collaterally assign some of the policy benefits to your employer. The IRS treats your employer’s premium payments like a loan to you for tax purposes. 

• Endorsement agreement/economic benefit: If your employer owns your split-dollar life insurance policy but you and your beneficiaries receive some of the benefits, your employer grants you those benefits with an endorsement agreement. The IRS taxes the policy as an economic benefit to you.

In either type of agreement, how and when your split-dollar plan ends is laid out in your contract. Often if you leave the company for another job or retire, the company either terminates your policy or gives you the option to continue the insurance coverage at your own expense.

How is split-dollar life insurance taxed?

In collateral assignment/loan regime agreements you own the policy but your employer still receives some of the benefits — either from the cash value or from the death benefit, depending on your contract — which functions as repayment for the premiums they pay into the policy. You’ll pay taxes on some percentage of the premiums (your “loan”), depending on your premium amount and IRS rules. 

An endorsement agreement/economic benefit scenario is more similar to a standard group life insurance benefit. Your employer owns and pays for the insurance policy and your beneficiaries are the primary recipients of the policy’s cash value and/or death benefit. You’ll pay taxes on the value of the benefits you receive from your policy.

How does split-dollar life insurance work for estate planning?

Also known as private split-dollar life insurance, split-dollar agreements between individuals or involving an irrevocable life insurance trust are rarely necessary for an estate plan. The main benefit of a private split-dollar contract is protecting your life insurance proceeds from an estate tax, which only applies if you have assets of $11.7 million or more. 

Depending on how you execute the private split-dollar plan you may face a gift tax, which applies to assets gifted between family members. There’s a yearly limit of $15,000 and a lifetime threshold equal to the estate tax limit. Work with a certified financial planner if you want to explore this option.

Compare the market, right here.

Policygenius saves you up to 40% by comparing the top-rated insurers in one place.

Get Started

If you are interested in making split-dollar life insurance part of your business or estate plans, make sure to work with a licensed professional to compare your options. Business owners looking to insure some of their most important employees can consider a split-dollar agreement or a simpler key person life insurance plan with term life insurance. High-net-worth individuals may find more advantageous methods for managing their estate. The best plan for you will depend on the financial needs of your business, business partners, and your family.