What Is a Split-Dollar Life Insurance Plan?

A split-dollar life insurance plan is a contractual arrangement where two or more parties share the costs and benefits of a life insurance policy. This agreement typically involves dividing premium payments, cash value, and death benefits between participants. Often used in business or family contexts, it allows parties to collaborate on securing life insurance coverage.

Core Components and Operation

A split-dollar life insurance plan centers on a life insurance policy, with specified parties sharing its financial elements. Primary parties include an employer and an employee, a corporation and a shareholder, or family members. One party, often the employer or a wealthier family member, typically pays all or a substantial portion of the policy premiums. This payment structure allows the other party, such as an employee, to access coverage they might not otherwise afford.

The policy’s benefits, including the death benefit and accumulating cash value, are divided between the parties. For instance, the premium-paying party might retain an interest in the cash value equal to their cumulative premium contributions. The death benefit is also allocated, with a portion often designated to the premium-paying party to recover their outlay, and the remainder going to the insured’s beneficiaries. The underlying life insurance policy, usually a permanent policy with a cash value component, facilitates this shared arrangement.

The policy’s cash value grows over time, offering a savings component accessible during the insured’s lifetime. This accumulation provides funds that can be borrowed against or withdrawn. A written agreement formalizes the specific division of these financial elements, defining each participant’s rights and obligations. This agreement ensures clarity regarding policy decisions, such as beneficiary designations or policy loans. The party with ownership rights generally holds more control over the policy.

Arrangement Structures

Split-dollar arrangements are structured in two ways: the endorsement method and the collateral assignment method. Each dictates the legal ownership of the life insurance policy and how its benefits are divided.

In an endorsement arrangement, the employer or other premium-paying party typically owns the life insurance policy. The policy is legally issued in their name, giving them direct control. The employer then endorses a portion of the death benefit to the employee’s designated beneficiary and pays premiums directly to the insurer. Under this structure, the employer usually retains all rights to the policy’s cash value. Upon the insured employee’s death, the employer receives a portion of the death benefit, often equal to the premiums paid or the policy’s cash value, whichever is greater. The remaining death benefit is paid to the employee’s beneficiaries, as specified by the endorsement. This method provides the employer with control over their premium outlays.

Conversely, the collateral assignment arrangement operates differently. The employee or insured party owns the life insurance policy from its inception. The employee is responsible for paying premiums, though the employer often provides funds, typically as a loan. To secure the employer’s interest, the employee assigns a portion of the policy’s cash value and death benefit to the employer as collateral. This collateral assignment secures the employer’s premium contributions or loans. If the employee dies, the employer recovers their contributions from the death benefit first. Any remaining death benefit is then paid to the employee’s beneficiaries. This structure provides the employee with direct ownership while protecting the employer’s financial interest.

The primary distinction lies in who holds legal ownership. These ownership differences dictate which party has primary control over policy decisions and how the policy’s cash value and death benefit are legally allocated.

Tax Implications

Split-dollar life insurance arrangements carry various tax implications depending on the chosen structure and benefits provided. Internal Revenue Service (IRS) guidance, including Treasury Regulations Section 1.61-22 and Revenue Ruling 2003-7, categorizes these arrangements into two tax regimes: the economic benefit regime and the loan regime.

Under the economic benefit regime, typically for endorsement arrangements where the employer owns the policy, the employee is taxed on the value of the economic benefit received. This includes the cost of current life insurance protection, determined by IRS Table 2001 rates or the insurer’s one-year term rates if lower. Any vested interest in the policy’s cash value is also taxable income to the employee in the year it vests, even without direct cash receipt.

The loan regime primarily applies to collateral assignment arrangements, where the employee owns the policy and employer premium payments are treated as loans. These can be demand loans, repayable upon request, or term loans, repayable on a specific date. If the loan is interest-free or bears a below-market interest rate, the foregone interest is taxable income to the employee and a deductible expense for the employer, under Internal Revenue Code (IRC) Section 7872. This imputed interest can create annual taxable income for the employee.

Gift tax implications can arise in family arrangements when one family member provides benefits to another. If the value of transferred benefits, such as economic benefit of coverage or foregone interest on a loan, exceeds the annual gift tax exclusion ($18,000 per donee for 2024), a taxable gift may occur. Any excess reduces the donor’s lifetime gift and estate tax exemption.

Estate tax considerations are also relevant. If the insured possesses “incidents of ownership” over the policy, such as the right to change beneficiaries or borrow against cash value, the entire death benefit may be included in their taxable estate under IRC Section 2042. Careful drafting ensures the insured does not retain such incidents of ownership if estate tax exclusion is desired. The “transfer for value” rule, found in IRC Section 101, can also impact the income tax treatment of the death benefit if the policy is transferred for valuable consideration, potentially making it partially taxable upon receipt.

Ending the Arrangement

Terminating a split-dollar life insurance arrangement involves specific steps to settle the financial interests of all parties. Cessation can occur through the death of the insured, policy surrender, mutual agreement, or policy transfer. Each method triggers a defined process for distributing the policy’s value.

Upon the insured’s death, death benefit proceeds are distributed according to the split-dollar agreement. The party that contributed premiums or provided a loan typically recovers their investment first. For example, in a collateral assignment arrangement, the employer’s loan is repaid from the death benefit, with the remainder going to the employee’s beneficiaries. In an endorsement arrangement, the employer receives their designated portion, often their premium contributions, and the balance goes to the beneficiaries.

Alternatively, the arrangement may terminate during the insured’s lifetime, often through a “rollout” or “cashing out” process. A rollout involves the employee or insured party purchasing the employer’s interest in the policy by repaying premium contributions or outstanding loans. This repayment can be funded by a policy loan, cash value withdrawals, or external funds. Once the employer’s interest is satisfied, the employee gains full ownership and control.

Policy surrender is another way to end the arrangement, where the policy is terminated with the insurer, and its cash surrender value is distributed. The distribution of this cash value is governed by the split-dollar agreement, ensuring each party receives their agreed-upon share. The agreement outlines how the policy’s cash value or death benefit will be divided, including accounting for any outstanding loans, accrued interest, or return of premium contributions.

Citations

Split-Dollar Life Insurance Arrangements. Internal Revenue Service. Retrieved from https://www.irs.gov/pub/irs-drop/n-02-08.pdf
Treasury Regulations Section 1.61-22. Legal Information Institute. Retrieved from https://www.law.cornell.edu/cfr/text/26/1.61-22
Revenue Ruling 2003-7. Internal Revenue Service. Retrieved from https://www.irs.gov/pub/irs-drop/rr-03-07.pdf
Internal Revenue Code Section 7872. Legal Information Institute. Retrieved from https://www.law.cornell.edu/uscode/text/26/7872
Gift Tax. Internal Revenue Service. Retrieved from https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes
Internal Revenue Code Section 2042. Legal Information Institute. Retrieved from https://www.law.cornell.edu/uscode/text/26/2042
Internal Revenue Code Section 101. Legal Information Institute. Retrieved from https://www.law.cornell.edu/uscode/text/26/101