When to use Split-Dollar Life Insurance

Split-dollar life insurance is a special type of life insurance that is designed to help pay for the costs of a terminal illness. Understanding when to use them is a key piece to making wiser policy and financial decisions.

  1. When an employer wants to provide a key employee or shareholder employee with a valuable benefit at a relatively low long-term cost. In fact, in certain situations the employer’s only real cost (aside from the drafting of the documents) is the after-tax cost of the use of its money. In other words, the employer pays for a split-dollar plan by giving up only the after-tax income the employer’s portion would have earned had it been invested by the employer.
  2. When an employer seeks an employee benefit that is highly flexible and avoids the aggravation involved in most other benefit plans, yet yields a high return in terms of employee appreciation. The employer can decide who will be covered and the terms and benefit levels each covered employee will receive. The plan can be designed so that the employer can modify or terminate it to meet changing circumstances, even in split-dollar life insurance.
  3. When a corporation wants to facilitate a cross-purchase of its stock. Two or more shareholders can purchase policies on each others’ lives and have the corporation pay all or most of the premiums. Each policy owner will pay a portion of premium equal to the pure insurance cost (a.k.a., the Reportable Economic Benefit (REB) cost) for the insurance owned on the other shareholder’s life based on the age of the insured shareholder (not the age of the policyowner-shareholder) (see “Tax Implications,” later). Alternatively, the corporation can pay the entire premium and the policy owners will be taxed on the REB cost. At the death of the insured, the policy owner will receive the death proceeds and use that cash to buy stock from the decedent shareholder’s estate.
  4. When a business owner needs estate liquidity and would like to tap business dollars to amass the available cash for his or her estate.
  5. Whenever one party (such as a senior family member) is able and willing to help another party (such as a junior family member) subsidize the cost of providing financial security through life insurance. This type of arrangement is commonly known as private split-dollar.
  6. Whenever an insured desires to have life insurance owned outside the estate (e.g., in a trust) for the purpose of providing estate liquidity and wants to minimize the gift tax consequences of paying the premium payments (i.e., the gift is limited to only the REB cost rather than the entire premium). This is also a type of private split-dollar arrangement.
  7. When an income tax free benefit is desired as an alternative to the taxable death benefit of a nonqualified deferred compensation plan. The use of split-dollar life insurance to provide a tax-free pre-retirement death benefit in conjunction with a nonqualified deferred compensation plan to provide taxable retirement benefits is often referred to as the “Dynamic Duo.”
  8. When there is a significant income tax bracket differential between the employer and the employee. When the employer is in a lower tax bracket than the employee, the employer can pay the same premium with fewer taxable dollars than the employee. For example, suppose the premium is $10,000 a year. To an employer in a combined federal and state bracket of 30 percent, it costs only $14,286 to pay the premium. To an employee in a 40 percent combined bracket, it costs $16,667. (If the employer is in a significantly higher tax bracket than the employee, a Section 162 executive bonus may be appropriate. See Chapter 40, “Section 162 Plans.”)
  9. When the client is in impaired health or for some other reason must pay a rating on a life insurance policy. The insured employee generally reports the economic benefit received just as a standard risk insured would have to. Ironically, this is advantageous because the reportable income is based on standard rates no matter how much higher than normal the premium may be.

Learn more about Split-Dollar Life Insurance here.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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