Split dollar life insurance is not an insurance product, but rather a method of paying for an insurance policy. The cost of any kind of insurance can be prohibitive in some cases, especially when the coverage needs to be substantial. Split dollar life insurance was developed as a way to make it more affordable by sharing the cost of the policy, or the premium, between two or more parties, usually an employer and employee. The split dollar life insurance arrangement can be beneficial in several situations.
For example, a company may wish to give a benefit to a favored employee. For older employees, insurance coverage can be relatively expensive, so the company can offer to pay the cash value portion of the premium, while the employee pays only the coverage aspect. This gives the employee the comfort of knowing that his or her family is provided for and serves the company’s purpose of motivating the employee. Upon the death of the insured, the death benefit is used to reimburse the company for its premium contributions and the remainder goes to the named beneficiaries.
A split dollar life insurance does not allow for any confusion surrounding the ownership of the policy. There are three main ways that the split dollar life insurance arrangement can be treated. The usual arrangement places the ownership of the policy firmly in the hands of the insured. The insured drafts legal documents stipulating that a portion of the death benefit that is equal to the employer’s contribution at the time of death is to be transferred to the company before the remainder is disbursed to the named beneficiaries. If the employee is no longer with the company, any contributions are repaid out of the cash value of the policy and the original agreement is dissolved.
With a collateral assignment, the employee is again the owner of the policy; however, the employee assigns the policy to the employer to be considered collateral, and the employer then pays a portion of the premium. In this instance, it is treated as a zero-interest loan and the employer is repaid the sum equal to its contributions upon the death of the insured. Finally, under the endorsement method, the employer buys the policy and is therefore the owner. The employee is named the beneficiary of the policy and there is a separate agreement that details how the benefits are to be distributed.
Under a split dollar life insurance policy, the premiums paid are not eligible for tax exemption. The employee is considered to be in receipt of an economic benefit so it is taxed as income. The company can however include the premiums as expenses to be deducted from pre-tax profits. The final reimbursement and death benefit are both tax-free.
