Life Insurance

Navigating Advantages: Split-Dollar Life Insurance Guide

Jack Ellis | Apr 18, 2024
Split-Dollar Life Insurance

Life insurance is a crucial financial tool that can help to provide protection and financial security for individuals and their loved ones. While the benefits and basic structure of traditional life insurance policies are well-known, there are alternative strategies like split-dollar life insurance that offer unique advantages. 

While Ethos does not offer split-life insurance products, it’s important to understand all of your options. In this article, we will explore what split-dollar life insurance is, how it differs from other types of life insurance, and how it can optimize benefits for policyholders. 

What is Split-Dollar Life Insurance?

Split-dollar life insurance is a sophisticated life insurance arrangement typically used in business and estate planning. It involves an agreement between two parties, often an employer and an employee or a high-net-worth individual and a family member or business associate. The term "split-dollar" refers to the way the premiums, death benefits, and cash values of the life insurance policy are shared between the two parties.

What are the key features of split-dollar life insurance?

A split-dollar policy has a few features that set it apart from other types of life insurance including  the following attributes:

Cost Sharing

In a split-dollar arrangement, the policy's cost, including premiums, is divided between the employer and the employee, or between the involved parties. This cost-sharing mechanism can be customized based on the needs and objectives of the individuals involved.

Policy Ownership

The policy is usually owned by one of the parties involved, typically the employee or the high-net-worth individual. This ownership structure can have important tax implications (which this guide will explore below).

Death Benefits

The death benefits, the amount paid out to beneficiaries upon the insured's death, are also divided between the parties based on the agreement terms.

How is split-life insurance different from traditional life insurance?

There are two key ways that split dollar life insurance policies differ from traditional life insurance:. 

Ownership structure

Unlike traditional life insurance policies where the policyholder owns the policy, split-dollar life insurance allows for more flexibility in ownership. 

In a split-dollar life insurance arrangement, ownership of the life insurance policy can be structured in various ways depending on the goals and preferences of the parties involved. The two common ownership structures are "endorsement" or "collateral assignment" arrangements.

Endorsement method: In the endorsement method, the employer typically owns the policy, and the employee is named as the insured. The employer pays the premiums and is entitled to recover its premium outlay plus interest from the policy's death benefit. Any remaining death benefit is then directed to the employee's beneficiaries. The employer has more control over the policy in terms of designating the insured, beneficiaries, and managing the policy.

Collateral assignment method: In the collateral assignment method, the employee or the insured individual typically owns the policy. The employer pays the premiums and, in return, is entitled to recover its premium payments upon the death of the insured, often with interest. The remaining death benefit goes to the policyowner's beneficiaries. The employee or policy owner has more control over the policy, including designating beneficiaries and making decisions about the policy.

Premium payment

While traditional policies are funded entirely by the policyholder, split-dollar arrangements allow for the sharing of premium payments. This can be especially beneficial in employer-employee relationships or when individuals want to pool resources for a common goal.

What are the key benefits of split-dollar life insurance?

So why would someone want to get a split-dollar policy rather than one on their own? There are a few main benefits for people in certain situations. 

Tax efficiency

Split-dollar life insurance offers various tax advantages. By structuring the policy appropriately, individuals can minimize their tax liabilities. For instance, the death benefit may be received tax-free by beneficiaries, and the cash value growth can accumulate tax-deferred.

Ownership structure can have significant implications for tax treatment, accounting, and the overall success of the split-dollar arrangement, however. Additionally, the tax implications may vary based on whether the split-dollar plan is used for personal or business purposes.

Consult your tax professional for more information regarding the taxation of split dollar life insurance.

Estate planning

Split-dollar life insurance can be a valuable tool for estate planning. The death benefit can provide liquidity to cover estate taxes, ensuring that heirs receive their inheritance without the burden of a significant tax liability.

Employee benefits

In employer-employee relationships, split-dollar arrangements can serve as a powerful employee benefit. By providing life insurance coverage as part of the compensation package, employers can attract and retain top talent while fostering loyalty among employees.

Wealth transfer 

For high-net-worth individuals, split-dollar life insurance can facilitate efficient wealth transfer strategies. By leveraging the policy's death benefit, individuals can transfer assets to heirs with reduced tax consequences.

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Do split-dollar insurance plans have drawbacks?

While split-dollar life insurance offers various advantages, there are some potential downsides as well. Like any financial strategy, split-dollar arrangements may not be suitable for everyone, and individuals should carefully weigh the drawbacks before opting for this type of life insurance. Here are some potential considerations:

Complexity and administration. Split-dollar arrangements can be complex and require meticulous administration. Understanding the terms of the agreement, ensuring compliance with tax regulations, and managing ongoing responsibilities can be challenging.

Tax implications. While split-dollar life insurance can offer tax advantages, it depends on the structure of the arrangement. Improper planning or changes in tax laws could impact the expected tax benefits, making it essential to stay informed and adapt the strategy accordingly.

Interest: In some split-dollar arrangements, loans may be involved to cover the premiums. Careful planning is necessary to minimize the impact of interest on the overall financial strategy.

Potential for disputes: Split-dollar agreements often involve multiple parties, such as employers and employees or family members. Differences in expectations or changes in relationships could lead to disputes over the terms of the arrangement. Clearly defining roles and responsibilities in the initial agreement and periodically reviewing it can help mitigate potential conflicts.

Limited flexibility: Once a split-dollar life insurance arrangement is established, making changes to the terms or structure can be challenging. This lack of flexibility may pose difficulties if there are significant changes in the financial situation or goals of the parties involved.

Cash value risk: Depending on the structure of the split-dollar arrangement, the cash value of the policy may not grow as quickly as in other types of life insurance. Individuals should carefully assess the long-term implications and potential trade-offs in terms of cash value accumulation.

Impact on employee benefits: In employer-employee relationships, the use of split-dollar life insurance may have implications for employee benefits and compensation reporting. Employers should consult with HR and legal professionals to ensure compliance.

Regulatory changes: Changes in tax laws and regulations can impact the effectiveness of split-dollar arrangements. Individuals utilizing this strategy should stay informed about any legislative changes that may affect the tax treatment of split-dollar life insurance.

Is split-dollar life insurance right for you?

Split-dollar life insurance is a versatile financial planning tool that offers a range of advantages, from tax efficiency to enhanced estate planning. Its ability to customize ownership structures and premium payment arrangements makes it a worthwhile option for some individuals seeking tailored life insurance solutions. But it’s a complex product, and you should consider consulting with financial and legal professionals to ensure that the strategy aligns with your goals and complies with current tax regulations.

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