Q

What is split-dollar life insurance?

A

Split-dollar life insurance is a contract between two or more parties to split the ownership and benefits of a permanent life insurance policy, should something happen.

Amanda Shih author photo

By

Amanda Shih

Amanda Shih

Licensed Insurance Expert

Amanda Shih is an insurance editor and licensed Life, Health, and Disability agent at Policygenius in New York City. Her work has appeared in Slate, Lifehacker, Jetty, and J.D. Power.

Updated June 4, 2021|4 min read

Policygenius content follows strict guidelines for editorial accuracy and integrity. Learn about our

editorial standards

and how we make money.

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 key employees, 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. It isn’t technically 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.

Key Takeaways

  • A split-dollar agreement is a permanent life insurance policy with a cash value shared between at least two people or organizations

  • It’s most common between employers and executive employees, but can also be used for private estate planning

  • The person who owns the policy, pays premiums, and receives the benefits varies, as do the tax implications

How a split-dollar plan works

Split-dollar life insurance is an agreement in which the payment anddeath benefitof 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 share the costs and benefits of a cash value life insurance policy. But agreements 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 agreement.

Though it’s possible to employ a split-dollar agreement for a personal life insurance policy, it’s only useful if you need to minimize your estate taxes. Most people won’t need to worry about this because federal estate taxes only apply to assets above $11.7 million (though your own state might have its own, lower limits). [1]  

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 policy can be owned by:

  • You: You can own a life insurance policy while 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.

There are two types of ownership agreements between businesses and employees: an economic benefit/endorsement agreement and collateral assignment/loan regime.

Economic benefit & endorsement agreement

If your employer owns and pays premiums for the life insurance policy in a split-dollar agreement, but you and your beneficiaries get some of the benefits, those benefits are assigned to you using an endorsement agreement. 

How it’s taxed: The term economic benefit refers to the way the IRS taxes the policy. The policy is taxed as employee pay, and calculated annually based on the benefits in your policy and the premiums paid by your employer.

Collateral assignment & loan regime

If you own the life insurance policy in the agreement but your employer pays the premiums and gets some of the policy benefits, you assign those benefits to your employer with a collateral assignment agreement. 

How it’s taxed: The IRS treats the premiums paid by your employer as an annual, interest-free loan to you (i.e., a loan regime). Their share of the policy benefits repayment for the loan. You pay tax on the interest that would have been charged if this were a traditional loan (known as the applicable federal rate or AFR). 

Loan regime agreements are more complex to set up, but have greater tax benefits because you are not taxed on the value of your policy benefits.

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

Ready to shop for life insurance?

Start calculator

Pros and cons of split-dollar life insurance

It’s less likely that you’ll see a split-dollar contract today, after tax regulations for the benefit became stricter in 2003. [2] However, it still has some uses in small business 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

  • Helps 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:

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

Also known as private split-dollar life insurance, these are agreements between individuals or involving an irrevocable life insurance trust. The contracts protect your life insurance proceeds from an estate tax. 

Depending on how you execute the 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. [3] Work with a certified financial planner if you want to explore this option.

Ready to shop for life insurance?

Start calculator

If you are interested in making split-dollar life insurance part of your business or estate plans, make sure to consult a licensed professional. The best plan for you will depend on the financial needs of your business, business partners, and your family.

Split-dollar life insurance FAQ:

How does split-dollar life insurance work?

Split-dollar life insurance agreements allow two or more parties to share the benefits of a permanent life insurance policy. The policy owner and division of benefits can vary.

How is a split-dollar arrangement taxed?

If the arrangement is between employer and employee, you pay taxes based on the premiums paid by your employer or on the value of the benefits you could receive from the life insurance policy.

Who pays for a split-dollar life insurance policy?

It’s different for every agreement but premiums are usually paid in whole or in part by you, your employer, and/or a business partner.

Who should get split-dollar life insurance?

Employers could consider including a split-dollar agreement in a benefits package or as part of a buy-sell agreement between business partners. High-net worth individuals might be able to use a policy to avoid estate taxes.

More about

Life Insurance

Accidental death and dismemberment insurance (AD&D)

AD&D insurance only pays out the death benefit if you are seriously injured or die from an accident.

Read more

What is supplemental life insurance?

Supplemental life insurance is optional additional coverage through your employer, but a private life insurance policy or rider is a better choice for most.

Read more

Key Person Insurance

Key person insurance is a life insurance policy taken out on an executive member of a business. The business is the beneficiary and pays the premiums.

Read more