Life Insurance: Why Businesses Should Split the Dollar

If you are a business owner or a family that has engaged in estate and gift tax planning, you’ve likely encountered the phrase, “split dollar life insurance.” Your first question might be, “Why would anyone split a dollar?” Well, as it turns out, split dollar life insurance plans have nothing to do with splitting dollars. They are often useful arrangements for businesses looking to retain key employees, owners who want to create benefits for themselves and families hoping to transfer their wealth in a tax-efficient manner.

Split dollar life insurance refers to the concept of two or more parties splitting the benefits and costs of a life insurance policy. Most commonly, split dollar life arrangements involve an employer and an employee or owner, with one party owning the policy, one or both parties contributing to the annual premium and both parties having some interest in the policy’s cash value and death benefit.

An Inexpensive and Valuable Executive Benefit

Split dollar life insurance plans are increasingly popular as a relatively inexpensive, easy-to-administer and valuable executive benefit arrangement. In fact, a split dollar life insurance policy was the centerpiece of a new contract for University of Michigan Head Football Coach Jim Harbaugh. 1 So how does a split dollar life insurance plan work as an executive benefit? Here are the basics of a typical plan:

— One party establishes a cash value life insurance contract under the ownership of the key executive.

— The employer lends money each year to the employee, solely for the purpose of paying premiums on the life insurance policy. Typically, the employer writes checks directly to the life insurance company.

— The employer receives a “collateral assignment” against the policy, entitling it to receive back the lesser of the policy’s cash value or the outstanding loan balance. The same assignment entitles the employer to a portion of the policy’s death benefit, equal to the outstanding loan balance.

— The key executive pays taxes each year on the interest attributable to the employer’s loan for premium payments.

— At some point in the future, the split dollar arrangement terminates when the employer’s loan is repaid (typically from the policy’s cash value), leaving the executive “free and clear” ownership of the accumulated gain in the life insurance policy.

— The executive can access the accumulated gains in the policy by borrowing against it, which will typically allow for tax-free access to the values. The policy loan is repaid to the insurance company at the death of the executive, and any residual death benefit is paid to the executive’s named beneficiaries.

While it sounds a little complicated, a split dollar life insurance arrangement can be much easier and less expensive to implement and manage than a traditional deferred compensation or other executive benefit arrangement. Some of the key advantages include:

— Relatively simple up-front document preparation.

— No ongoing administrative cost.

— Cost recovery for the employer.

— Exempt (generally) from the rules of IRC Section 409A.

— Little or no impact on the company’s balance sheet.

— Straightforward annual accounting entries.

— The ability for employers to set performance objectives to trigger funding of the policy.

— The ability for employers to set restrictions on when the cash value can be accessed (i.e., “golden handcuffs” to help with retention).

A Benefit Especially Valuable in Today’s Low-Interest Rate Environment

Executives benefit from the difference between the rate of return on the policy’s cash value compared to the amount of tax paid on interest for the premium loan. Today’s low-interest rate environment makes that benefit particularly attractive.

At today’s applicable interest rates, an executive would benefit from all of the return in the life insurance contract in excess of 1%. Here’s how: As of July 2018, the blended “applicable federal rate” was 2.03%. 2 This is the rate typically applied to premium loans under split dollar life insurance plans. The executive’s “tax cost” would be the approximately 35–40% income tax on the 2.03% interest, or approximately 0.71–0.81% of the outstanding premium loan. The executive then benefits from any return on the premium loans inside the life insurance policy in excess of the 0.71-0.81% “tax cost.”

Should your business consider a split dollar life insurance plan? It may be worth a discussion with your tax and legal advisors, as well as an experienced life insurance advisor.

Contact a Wipfli Financial advisor to start the conversation!

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Wipfli Financial Advisors, LLC (“Wipfli Financial”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940. Wipfli Financial is a proud affiliate of Wipfli LLP, a national accounting and consulting firm. Information pertaining to Wipfli Financial’s management, operations, services and fees is set forth in Wipfli Financial’s current Form ADV Part 2A brochure, copies of which are available upon request at no cost or at www.adviserinfo.sec.gov. Wipfli Financial does not provide tax, accounting or legal services. The views expressed by the author are the author’s alone and do not necessarily represent the views of Wipfli Financial or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Wipfli Financial, and Wipfli Financial does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Wipfli Financial of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
Brad Mueller
Brad Mueller

CLU, ChFC | Principal, Chief Practice Officer

Brad Mueller, CLU, ChFC, is a Principal and the Chief Practice Officer of Wipfli Financial Advisors, based in Madison, WI. Brad specializes in insurance and risk-management consulting for business owners and family offices.

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Life Insurance: Why Businesses Should Split the Dollar

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