If you own a closely held business or are a senior executive at a major corporation, you know the importance of rewarding, retaining and recruiting key employees. Key employees are as important to the success of your business as the product or service you provide. Split Dollar arrangements can be an advantageous alternative to adding new fringe benefits, increasing compensation or enhancing current incentive programs.
Split Dollar Plans are a cost-effective and tax-efficient way to provide benefits using life insurance. Split Dollar gets its name because it involves splitting the benefits of a life insurance policy between you and your key employee. A Split Dollar arrangement can be used by an employer to provide valuable life insurance death benefit protection for select key employees. The employer can be a C or S corporation, partnership, LLC or even a sole proprietor. The insured may be the employee or anyone in whom the employee has an insurable interest (such as a spouse, parent, child or business associate). Family or private Split Dollar Plans may also be structured between family members (parents and children) or between insureds and their irrevocable life insurance trusts (ILITs).
Please call (877) 972-3262 or contact us for the Exclusive Split Dollar Whitepaper now. This comprehensive whitepaper will provide every detail you need to know about Split Dollar arrangements.
How Does Split Dollar Work?
The employer or company buys a large life insurance policy on a key employee and pays the premium through after tax dollars. The employer is the owner of the policy and has access to policy cash value and controls the policy.
- The key executive is the insured and chooses the beneficiary or beneficiaries of the life insurance policy.
- At the death of the key executive, the company receives back the entire premium or cash value whichever is higher. At the same time, the executive’s beneficiaries receive the balance of the death benefit income tax-free, as with any life insurance policies.
There are two types of Split Dollar arrangements: Endorsement (or Economic Benefit) and Loan Regime.
Endorsement Arrangement: The employer pays all of the premiums and owns all of the policy cash value. The death benefit is split between the employer and the employee’s named beneficiaries, with the employer being entitled to an amount at least equal to its cash value interest.
Split Dollar Loan Arrangement: The employer pays all or a portion of the employee’s life insurance policy premiums as a loan. The employer has a collateral assignment against the policy to ensure recovery of the loan.
Split Dollar is Advantageous for Employers and Employees
Selectivity: You decide who participates and the benefit levels for each employee. Split Dollar gives you the flexibility to choose a group of executives or just one key employee with the versatility to have a different benefit for each.
Easy to establish and administer: IRS approval is not required, and administration is minimal.
Split Dollar is an asset: Policy cash values are an asset on the business’ balance sheet, and the cash value grows on a tax-deferred basis.
Cost-effective: Unlike other fringe benefits, the business normally recoups the cost, and the death benefit proceeds are normally received income tax free.
Leverage: A Split Dollar arrangement may cost less than the after-tax compensation dollars required to provide an equivalent benefit.
Employee productivity and loyalty: Key employees will feel valued and will be more productive. “Golden handcuff” provisions can be included by promising a future deferred compensation benefit informally funded with policy cash values, giving key employees incentive to remain loyal to the business.
Versatility: Split Dollar arrangements can be used in a variety of ways to meet an executive’s or a business owner’s estate planning and business needs.
More meaningful: The employee enjoys insurance protection when he or she needs the coverage the most.
Cost and tax-effective: The employer generally pays the entire premium, the employee is taxed based on his or her share of the death benefit at a very attractive “term” rate.
Tax-free death benefit: Death benefit proceeds are generally received income tax free by the employee’s beneficiary.
Versatility: In addition to the financial protection life insurance in a Split Dollar arrangement provides, it can also be designed to help supplement retirement or estate planning needs.
Here’s an example for a 53 year-old executive:
- The company buys $5 million worth of whole life insurance and pays $133,400 annual premiums for 13 years (total premiums $1,734,200)
- Because this is a whole life insurance policy, there is no stock market risk and the premiums earn an attractive fixed return. As with other whole life policies, there are three guarantees: stable premiums, an unchanging death benefit and increasing cash value.
- If this executive were to die at age 54, the company would get back $133,400 (the one premium paid) and the executive’s family would get $4,866,600 ($5,000,000 – $133,400)
- If this executive were to die at age 70, the company would get back $2,136,154 (the cash value is higher than the total premium of $1,734,200) and the executive’s family would get $3,376,482 (now the death benefit is higher $5,512,636 – $2,136,154)
- If this executive were to die at age 88, the company gets back $4,869,852 (the cash value is higher than the total premium of $1,734,200) and the executive’s family would get $1,420,355 (now, both the death benefit and the cash value are a lot higher $6,290,207 – $4,869,852)
- This policy lasts until the executive dies, but the amount of split benefits will change. The company can use this cash value as a savings account and utilize it at anytime with few days’ notice. As you can see this cash value earns very attractive rate of return along with tax-deferred growth.
Obviously, the numbers will change for different age groups of executives and different death benefit amounts. Another option is using Guaranteed Universal Life Insurance instead, which would have a lower premium, no cash value build up and higher death benefits for the beneficiaries of the insured.
Split Dollar and Deferred Compensation
The combination of Split Dollar and Deferred Compensation permits the employer to control the life insurance policy cash values during the employee’s working life. Split Dollar allows the employee to receive life insurance death benefit protection at a very low tax cost that will be paid to his or her named beneficiary income tax free. All benefits paid as Deferred Compensation, including a promised pre-retirement death benefit, are taxable as ordinary income to the recipient beneficiary. Adding a Split Dollar arrangement means that any death benefits paid to the employee’s named beneficiary in excess of the amount received by the employer (usually the life insurance policy’s cash value) are generally received income tax free by the employee’s beneficiary.
Whichever way you go about it, Split Dollar arrangements create a win-win scenario for both the company and the key employee! Even though, Split Dollar arrangements are easy to set up and administer but you require experienced advisers to establish and manage for you. We have set up and are managing thousands of Split Dollar, Deferred Compensation, Defined Benefit and other Executive Bonus Plans across the country for last 17 years for sole proprietorship to large corporations. Please call (877) 972-3262 or contact us for the further information.