Split-dollar life insurance is a plan under which the costs and the benefits of a life insurance policy are split between two parties-usually an employer and a valued employee. The term split-dollar" refers to a way to pay for and share in the benefits of the insurance, not to a particular type of life insurance policy.
Although this arrangement could be made between other parties, such as parents and children, a corporation and a stockholder, a sole proprietor and an employee for a buyout agreement, the most common usage is between an employer and an employee. The reasoning behind the employer's sharing costs with the employee for a life insurance policy is that the employer has greater financial assets and is in a position to help an employee meet life insurance needs.
Consult your insurance company for guidance on the use of collateral assignment and all forms of split-dollar arrangements.
Recent rules, and in particular the Sarbanes-Oxley Act, have prohibited several forms of Split-dollar plans, and, as stated later, at this point the only people that know from day to day as to the legality of the split-dollar plan, are the insurance companies (and some regulators) who stay on top of this ever-changing field. Still, split dollar assignments have been a powerful tool for solving many corporate problems through the medium of life insurance. Therefore, the following text will describe the split-dollar assignments as they were prior to this seemingly excessive regulation but it must be mandatory that the insurer establish the rules and policies that can still be legally sold, including some that are so new they are not mentioned in this text.
Unlike tax-qualified employee benefits, which must meet stringent requirements of the Internal Revenue Code, the Employee Retirement Income Security Act (ERISA), and other government-imposed nondiscrimination requirements, split-dollar insurance plans may be provided discriminately. That is, the employer may select precisely which employees will be covered by split-dollar insurance. This allows special benefits to be made available-legally-for employees the employer especially wants to reward. While split-dollar plans do not have the tax advantages of qualified benefits, the tax consequences are not severe. Taxation is covered later.
For the employer, there are at least these benefits to helping an employee secure life insurance under a split-dollar plan:
Since split-dollar insurance is intended primarily to benefit an employee, this arrangement naturally offers numerous advantages to the employer as well:
There are many ways to vary the details of split-dollar plans in order to meet different employer and employee needs, but typically, the employer and the employee jointly pay the premiums for a life insurance policy under which the employee is the insured. Permanent or cash value life insurance must be used because the cash values provide part of the mechanism that makes a split-dollar plan work.
In this method, the employer pays the part of each annual policy premium that equals the annual increase in cash values in the policy. The employee pays the balance of the annual premium. For example, assume the annual increase in cash values for the first year is $200 and the annual premium is $1,000. The employer pays $200 of the premium and the employee pays $800.
In the early years, the employee pays a substantial portion of the premium. However, as the cash values grow, the employer will take over the larger share of the premium. For example, suppose in a later year the annual increase in cash values is $700. Now the employer pays $700 and the employee pays only $300 of the $1,000 premium.
While the employee's burden appears high in the early years, many policies build cash values quickly so the employee eventually pays no portion of the premium. In addition, the basic split-dollar arrangement can be altered to help employees who are unable to pay high premiums in the early years.
Both parties split the benefits as well. If the employee dies, the employer is generally entitled to receive death proceeds from the policy equal to one of the following:
1. The cash value of the policy or
2. The amount of premiums the employer has paid.
The employee's beneficiary-named by the employee-receives the balance of the death benefit.
The employee is always entitled to name his or her own personal beneficiary. Furthermore, split-dollar policies are typically written so that the personal beneficiary may be changed only with the written consent of the insured employee.
Of course, the employee might not die (this situation is discussed later).
A concern that is sometimes expressed about split-dollar insurance is that, as the employer takes over larger amounts of premium payments, the employer becomes entitled to a larger share of the death benefit. Correspondingly, then, the employee's beneficiaries will receive a smaller death benefit, especially if the policy has been in effect for a long period. One way to offset this problem is to use a participating policy that pays dividends, which may then be used to add to the death benefit that will be paid to the employee's survivors.
Split-dollar Insurance may be set up using one of two basic forms of policy ownership-the endorsement method or the collateral assignment method.
Under the endorsement method, the employer owns the policy on the life of the insured employee. As owner, the employer is responsible for paying the premiums, but under the basic split-dollar plan, the employee agrees to share in premium payment. As indicated above, the employee's share is the excess over the annual increase in the policy's cash values.
In return, the employer is named beneficiary for a portion of the death benefit and the employee names a personal beneficiary for the balance of the death benefit. The employer's share is either the cash values or an amount equal to premiums the employer has paid. The personal beneficiary's share is the remainder of the proceeds.
The "endorsement" concerns the employee's right to name a personal beneficiary because this is, in fact, an endorsement attached to the policy granting the employee that right. Furthermore, the endorsement limits the employer's rights as policy owner since one of those rights would normally be to name the beneficiaries. However, the employer is forbidden, under the endorsement, from changing the employee's personal beneficiary unless the employee agrees to the change.
Some insurers allow a split-dollar endorsement arrangement to actually split the ownership of the policy as well. While not exactly an equal ownership split, this type of arrangement allows the employee to be named the owner of the amount of the death benefit over and above the policy's cash value. The employer still owns all other benefits and has all other ownership rights with the exception, again, of the right to change the employee's personal beneficiary. The employee still must consent to any change the beneficiary designation.
Using the collateral assignment method means the employee applies for and owns the life insurance policy on his or her own life. As owner, the employee is responsible for paying the premiums. However, a separate agreement is written in which the employer agrees to share in the premiums. Again, the amount the employer pays each year is the same as the annual increase in the policy's cash values. The employee pays the balance of the premium.
The agreement gives the employer the right to recoup from the death proceeds the premiums the employer paid. The employee assigns the policy as collateral for the premium payments, which are considered a “loan” form the employer. Typically, no interest is paid on the “loan,” although provisions could be made for the employer to eventually receive the equivalent of interest as well.
As owner of the policy, the employee names his or her own personal beneficiary. Under the collateral assignment method, the employer is not considered a policy beneficiary, but is, instead, the collateral assignee and, thus, is entitled to the specified share of the death proceeds.
Whether to use the endorsement or the collateral assignment method depends largely on the requirements of the people involved. If one of the employer's goals is to be able to borrow the cash values for business purposes, the endorsement method should be used since the business/employer is the policy owner under this method. As owner of the policy, the employer has all loan rights associated with the cash values. This is not the case with a collaterally assigned policy, which the employee owns.
The endorsement method is more convenient when the employer wants to use an existing key person policy for the split-dollar arrangement. The employer already owns the policy and some simple adjustments can be made to share the premium costs and to allow the key person to name a personal beneficiary for his or her share of the policy proceeds.
Split-dollar insurance is sometimes used to provide informal funding for non-qualified deferred compensation plans, which are discussed in a later chapter. Basically, these plans involve an agreement between an employee and employer to defer a portion of the employee's compensation until sometime in the future-generally after the employee retires. A split-dollar plan can be used for this purpose because the cash values will grow over the life of the policy, building up a nice sum of money to be paid later. At the employee's retirement, the employer may surrender the policy for its cash value and use the cash value to pay the deferred compensation to the employee. If this is the purpose, the endorsement method, where the employer owns the policy, is required because the deferred compensation must come from the employer's funds.
If the collateral assignment split-dollar arrangement is used for funding a deferred compensation plan, the employee would at some point be required to transfer ownership to the employer, which could result in a transfer for value rule violation. This is a problem when the employee is a non-owner, such as an employee who is not a stockholder or officer of a corporation.
If the employee to be covered already owns a life insurance policy on his or her life, this policy could be used in the split-dollar plan. In this case, the collateral assignment method would be simplest to implement since the employee already owns the policy. However, this assumes the employer has no particular reason, such as those mentioned above, for owning the policy.
In response to differing client needs, many insurance companies have adjusted, altered and refined the details of split-dollar life insurance plans over the years. Today, many variations of the basic split-dollar plan exist. Each version has unique twists that make the plan more appealing to customers with certain requirements. The insurers are the logical place to go for information as to what is legally available and how their plans might make available additional adaptations.
The simplest variation to the split-dollar plan occurs when the employer pays the entire premium. In other words, although the employer and the employee still share the policy benefits, the employer is willing to pay the entire premium with no contribution from the employee.
This is one way an employer may further reward a loyal employee, especially when the employee may be unable to make high premium payments in the early years of the policy. The only "cost" to the employee is being required to pay taxes on the economic benefit received. This taxation is required regardless of how the plan is set up. Basically, an economic benefit refers to anything of financial value an individual receives. The tax code provides a specific way to determine the taxable value of premium payments made on someone's behalf.
Another option is designed to solve the problem of very high employee contributions during the early years by providing for level employee contributions or averaging. This type of arrangement results in the employee making a lower contribution that remains constant over the years of the policy. One way to accomplish this is for the business to determine the total costs to the employee for the plan over a certain number of years-possibly until the employee's anticipated retirement date. T his amount is then divided by the number of years involved, arriving at a level premium contribution the employee will make annually.
For example, suppose total employee costs would be $30,000 over a 20-year period. Instead of paying higher early premiums and lower premiums in later years, the employee pays $30,000 for 20 years = $1,500 level annual premium
A common variation results in both the employer and the employee paying level premiums over a specified period. Suppose again the policy is anticipated to be in force for 20 years. The employer agrees to pay an annual premium equal to 1/20th of the cash value that the insurer guarantees will be available in the 20th year and the employee pays the balance of the premium.
Let's say the guaranteed cash value for a certain policy in the 20th year is $55,000. The total annual premium to be split between the employer and the employee is $3,650. The employer's annual premium contribution is 1/20th of $55,000 —$55,000 / 20 = $2,750 (employer's share of annual premium)
Determining the employee's share of the $3,650 annual premium is then a simple matter of subtraction such as Total annual premium $3,650. Minus employer's share — 2,750
Employee's share— $ 950
This arrangement does not change the basic operation of the split-dollar death benefit. That is, in the early years, the employee's share of the death proceeds is greater than the employer's. As the years pass, the employer's share (based on cash values) becomes greater and the employee's share becomes smaller. Another option available under certain policies to boost the employee's share of the death benefit is the fifth dividend option.
You know that participating life insurance policies pay dividends and the insured person has an option about how to receive them. The so-called fifth dividend option involves using dividends to purchase one-year term insurance in an amount equal to the policy's increasing cash value. As each one-year term passes, the dividends purchase a new one-year policy equal to the increased cash value at that time. Any excess dividends reduce the amount of premium the employee must pay so there is the double benefit of keeping the death benefit higher while reducing the employee's share of the premium.
Eventually, the dividend might not be adequate to cover the term insurance because the amount of insurance is increasing (along with the cash values) and the employee is growing older, which results in higher insurance rates. At that point, the employee's portion of the death benefit could become smaller, but still remain higher than it would have been without using the dividends to purchase more insurance. Still, the benefits in the early years of premium payment generally offset this disadvantage.
Another way to improve the employee's share of the death benefit in later years is to leave the policy's dividends to accumulate at interest in the easy years when the dividend might not be adequate to purchase one-year term insurance. The accumulated interest is added to the death benefit, again maintaining a higher share for the employee without compromising the employer's share.
Alternatively, the dividends could be used to purchase small amounts of paid-up life insurance, rather than term insurance. This option, too, would result in an additional death benefit for the employee's beneficiaries.
Both of these options for using dividends, notice, have no effect on the employer's portion of the death benefit. Only the employee's beneficiaries receive additional proceeds.
During the plan participant's lifetime, the insured is deemed to receive a current benefit because of the life insurance provided by the plan, such current benefit value is subject to taxation and must be included in the participant's income each year, but the amount that is included in income is usually much less than the actual life insurance premium.
Only the cost of the pure amount at risk is currently taxable, which is determined by simply subtracting the cash value of the policy at the end of the year from the policy fact amount. Example: Face amount $100,000, cash value $25,000, therefore the pure amount at risk is $75,000.
The value of this pure amount at risk ($75,000 in this case) is determined by applying the lesser of the Table 2001 rates (such rates provided by the IRS) and the insurer's published rates for one-year term insurance policies available to all standard risks to this amount. Note: It would serve no particular purpose to show these rates, which start at age 31 through age 90.
To illustrate how it works, if the plan participant is age 35, according to the table at age 35 the premium is $.99 (per thousand)—multiplying $.99 by 75 gives $74.25 for that year. Each dollar that the plan participant actually contributes on an after-tax basis to the plan will reduce the reportable economic benefit by an equal dollar.
As time goes by, the rate-per-thousand will grow, but in a whole life policy the amount of risk will decrease as the cash value increases, however, if the insurer that issued the policy has a one-year term policy that has lower premiums than the IRS rates (incidentally, are referred to as "Table 2001 rates"—those lower rates may be used. The total amount of the current reportable economic benefit that is recognized by the plan participant becomes their cost basis in the plan. An amount equal to this cost basis may be received by the plan participant tax free.
The employer pays the part of each year's premium that at least equals the increase in the cash value. The employee may pay the remainder of the premium, or the employer may pay the entire premium. When the increase in cash value equals or exceeds the yearly premium, the employer pays the entire premium. If the employee dies while in the service of the employer, a beneficiary chosen by the employee receives the difference between the face value and the amount paid to the employer (the cash value or the total of all premiums paid by the employer-whichever is greater). Thus, during employment, the employee's share of the death benefit decreases. I f the employee leaves the employer, the latter has the option of surrendering the policy in exchange for return of all premiums, or selling the policy to the employee for the amount of its cash value.
There are two types of split dollar life insurance policies: (1) Endorsement-the employer owns all policy privileges; the employee's only rights are to choose beneficiaries and to select the manner in which the death benefit is paid. (2) Collateral-the employee owns the policy. The employer's contributions toward the premiums are viewed as a series of interest-free loans, which equal the yearly increase in the cash value of the policy. The employee assigns the policy to the employer as collateral for these loans. When the employee dies, the loans are paid from the face value of the policy. Any remaining proceeds are paid to the beneficiary. (Dictionary of Insurance Terms. Also, IRS Publ. 525)
Under a single bonus plan, the employer pays the entire premium, but does so on a different basis. To understand the purpose of a bonus plan, you must first remember that the premiums the employer is paying for split-dollar life insurance are not tax deductible to the employer because the employer eventually receives a tax-free benefit—a portion of the death proceeds. Under a single bonus plan, the employer pays part of the premium amount to the employee as a bonus, which is tax deductible for the employer. The employee then uses this bonus to pay his or her share of the premium. While the employee must pay taxes on the bonus, remember that he or she will pay taxes anyway, on the economic benefit received if the employer pays the entire premium. The primary difference in these arrangements is that the employer gets a tax deduction for the bonus, but not for premium payments. The amount of the bonus is often the same as the cost determined under the Table 2001 as described above.
Optionally, the employer may fund the premium with a double bonus plan. By paying the employee a bonus equal to twice the Table 2001 costs, the employer provides money to offset the employee's taxes. Double bonus plans were especially popular when the individual income tax rates were much higher, so, for example, an employee in the 50% tax bracket could use the double bonus to pay taxes on the bonus.
In a basic split-dollar plan, no importance is placed on the time value of money in determining the return to the employer from the death proceeds. The employer receives a portion equal to cash values or premiums paid over the years. There is no recognition that the money spent by the employer could have received interest or been used for some other purpose that would have resulted in a gain for the employer if it had been used elsewhere.
However, the split-dollar plan may be arranged to recognize and benefit the employer for the time value of money. When the death proceeds or the cash surrender value is taken from the policy, the employer receives not only the return of investment, but also an amount equal to what a certain rate of interest would have provided over the years. To implement this arrangement, the agreement between the employer and the employee must specify what the rate of interest is and whether it is simple or compounded.
As stated previously, in the basic split dollar plan, the employer's portion of the death benefit is equal to either the cash surrender value of the policy or the amount of premiums the employer has paid. Under the so-called equity split-dollar arrangement, the employer agrees to receive a return only of premiums it has paid during the policy period. Any excess equity in the cash values, over and above premiums the employer has paid, belongs to the employee. If the employee dies, the business recovers its premiums and the employee's personal beneficiary receives the death benefit plus any excess cash values. The excess cash values are essentially combined with the death benefit so the tax consequences remain the same as they would be for the face amount death benefit alone.
If the employee lives and the policy is surrendered for its cash values, the employee receives the excess equity, while the employer recoups the premiums it paid.
As its name implies, a reverse split-dollar plan reverses the functions and benefits of the basic plans we've discussed. The goal of reverse split-dollar plans is to provide the employee with considerable cash for future use, and not so much for life insurance protection.
In this case, the employer pays for the life insurance costs and the employee pays for the cash value increases-exactly the reverse of basic plans. The employer’s portion of each annual premium is based on the rates discussed previously and the employee pays the balance. Again, this is the reverse of basic split-dollar arrangements. Of course, this could be combined with an "employer pays all or some other arrangement under which the employee pays nothing out-of pocket for premiums.
If the employee dies, the employer, who essentially has key person life insurance on the employee's life, receives the death benefit. Depending on the particular arrangement, the employer may receive the full death benefit or the death benefit minus any premiums the employee had paid prior to death. These premiums would then be returned to the employee's personal beneficiary.
If the employee lives, which is the hope behind reverse split-dollar plans, the employer receives a return of premiums it has paid, and the remaining cash surrender value goes to the employee. This can provide a substantial amount of cash for the employee to use for retirement or other purposes as desired.
Reverse split-dollar plans became more popular with the advent of universal and variable life insurance policies, which provide the opportunity for greater growth than traditional whole life policies with lower interest rates. Some practitioners believe reverse split-dollar plans provide entirely too much tax benefit to the employee to continue unscathed by the IRS. This is true because the cash value build-up is currently treated like any other life insurance policy even though reverse split-dollar plans can provide significant benefits for which the employee may pay little or nothing in taxes. Currently, however, these plans can provide an important benefit for selected employees with minimal tax consequences.
The collateral assignment method of ownership is used with a reverse split-dollar plan, since this gives the employee full control over the policy's cash values, assigning only the agreed-upon portion of benefits to the employer.
The split-dollar arrangements presented above represent those that are most commonly used. The insurers with whom you do business might offer other “creative splitting” options from which your clients may choose.
Because split-dollar is a method for providing life insurance, the taxation rules you've learned for life insurance generally apply.
As is true for any other life insurance policy, premium paid are not deductible for anyone who has an interest in or is beneficiary of the policy. Thus, employers may not deduct their share of the premiums for split-dollar life insurance because employers are either the beneficiaries or the collateral assignees of the policy. Likewise, the portion of premiums the employees pay is not deductible since the employees or their survivors will benefit.
Earlier we mentioned that employees are taxed on the amount of economic benefit they receive as the result of their employers paying premiums for them. The IRS has ruled that an economic benefit is taxable income and that a life insurance premium that pays for insurance proceeds payable to the employee and/or an employee's personal beneficiary is such a benefit. The value of the economic benefit under a split-dollar plan, determined on an annual basis, is the one-year term insurance cost minus the portion of the premium paid by the employee.
The basis for determining the cost of one-year term insurance is either:
1. The government's Table 2001 rates or
2. The insurance company's own standard one-year term rates.
Generally, standard rates from the insurer issuing the policy are lower than the government's Table 2001. Therefore, where available, these rates generally would produce a lower taxable economic benefit for the employee.
Regardless of whether the employer or the employee owns the split-dollar life insurance and has the right to receive its cash values, the annual increases in cash values typically are not taxed during the year of increase. The exception is when the cash values help trigger an alternative minimum tax (AMT) for a corporation, whatever that might be as discussed earlier.
Taxation may occur when the employee lives, rather than dies, and at some point the employee, the employer or, usually, both (depending on the arrangement) will receive the life insurance policy cash surrender value. In the final section of this chapter, we'll deal with the taxation that occurs in the specific circumstances under which the cash values are paid. The general treatment follows.
If the employer receives no more than an amount equal to premiums it has paid, the employer has no taxable income from its portion of the cash values. If the arrangement includes payment of some rate of interest to account for the time value of the employer's money, the employer pays income taxes on the gain over premiums paid.
The employee pays taxes on the difference between the portion of the cash surrender values the employee receives and the amount he or she paid during the policy period.
When the covered employee dies, the split-dollar insurance death benefits generally are not taxable, either to the employer or to the employee's personal beneficiary. The only situations under which the death benefits might be taxed are:
1. The death benefits fail to qualify as life insurance proceeds under the tests provided by the IRS.
2. The transfer for value rule applies, causing the death proceeds to lose their tax-exempt nature.
3. The proceeds play a role in triggering the alternative minimum tax for the employer.
There have been three events (at least) over the past few years that have directly affected the tax treatment and even the legality of some split-dollar arrangements.
The IRS released final split-dollar regulations in TD9092, which clarifies that any money paid by an employer in a split-dollar arrangement that benefits the employee is going to be treated either as a taxable benefit to the employee or a loan to the employer.
Secondly, the passage of HR 3763 – also known as the Sarbanes-Oxley Act of 2002, the corporate ethics bill that among other things forbids loans from public companies to executives. One form of split-dollar arrangement (the collateral assignment method) is based on the premise of the employer "loaning money on the employer's behalf.
Also, Treasury Notice 2002-50 targets certain types of split-dollar arrangements (such as the reverse split-dollar) in which artificially high current term rates are used to reduce or avoid taxes.
The sale of life insurance under these split-dollar plans generally ceased as insurers and clients awaited the IRS promulgation of final regulations. Now that the final regulated have been published, it is likely that insurers and clients will need to fully evaluate the impact, especially in the light of Sarbanes-Oxley, before the split-dollar plans again assume a prominent place. The 64 dollar question will be, of course, of the public's perceived value of split-dollar plans in the new regulatory environment—which, as we have seen with estate taxation, et al, may be uncertain and liquid for some time to come.
The Corporate Responsibility Act of 2002 (the Sarbanes-Oxley Act or HR 3763) bans public companies from making certain personal loans to executives. Collateral assignment split-dollar is premised on the idea of company loans to the insured policyowner/employee. Since the target of the act are the highest paid corporate executives, passage of this law has halted the sale of this form of split-dollar for many insurance companies while they sort out what the new law really means to split-dollar.
Consult your insurance company for guidance on the use of collateral assignment and all forms of split-dollar arrangements
Under these ownership arrangements, if they are still applicable and available, the death proceeds paid to the employee's personal beneficiary would be included in the deceased employee's estate and subject to federal estate taxation, but death benefits are not included in the estate if the individual avoids the incidents of ownership described previously. However, even when the employer owns the policy under the endorsement method, the employee has the right to name a personal beneficiary under a split-dollar plan. This results in an incident of ownership, subjecting the proceeds to estate taxation. Some practitioners suggest that this can be avoided by giving the right to name or change the personal beneficiary to the beneficiary, rather than to the employee. This excludes the insured from having any rights under the policy that may be construed as incidents of ownership.
And, of course, under the collateral assignment method, the employee owns the policy—obviously an incident of ownership. Only the amount of the death benefit payable to the personal beneficiary is included in the estate—the portion paid to the employer is not included.
It is also possible to avoid incidents of ownership under a collateral assignment arrangement. The employee-insured's personal beneficiary could apply for and own the split-dollar life insurance policy on the employee's life. This beneficiary, then, would have the separate agreement with the employer, assigning the appropriate portion of the death benefit to the employer upon the employee's death.
The IRS has not been entirely consistent in ruling on the federal estate taxation of split-dollar life insurance policy proceeds. In one situation, a policy on a 50% shareholder resulted in the portion of the death benefit payable to a personal beneficiary being included in the estate because the shareholder had the right to name the beneficiary. On the other hand, the IRS ruled under a reverse split-dollar endorsement arrangement that all of the proceeds were to be included in the estate-both the employer's and the personal beneficiary's shares. However, the estate was also allowed a deduction for the portion paid to the employer.
In the case of a corporation's controlling stockholder, where the corporation owns the policy and the stockholder had no incidents of ownership, the personal beneficiary's portion of the death benefit generally is includable in the estate. This inclusion results from the attribution rules that attribute incidents of ownership by the corporation to a majority stockholder for proceeds payable to someone other than the corporation itself.
The IRS and the tax courts have issued a number of rulings on this issue that are not always consistent, to say the least. A client establishing a split-dollar plan should always consult with tax attorneys to ensure, as far as possible, that the desired outcomes occur.
A split-dollar plan terminates, of course, if the employee dies. If the employee lives, however, there are other reasons for terminating the plan. The employee might leave the company's employ. The employee might retire. There is even a point at which the costs associated with the Table 2001 rates make continuing the arrangement less attractive than in earlier years. Whatever the reason for terminating the plan, there are various ways to distribute the surrender values.
A split-dollar rollout involves taking a loan from the policy's cash values in order for the employer to recoup premiums paid, then transferring full ownership of the policy to the employee. Under the endorsement method, where the employer owns the policy, the employer takes the policy loan. Typically, then, the employer would sell the policy to the employee-insured for the difference between the cash surrender value (prior to the loan) and the amount of the loan. In this case, the employee, as the new policy owner, then becomes responsible for paying interest due on the loan. Some employers are willing to pay the employee a bonus to offset the amount of the interest payments.
Under a collateral assignment arrangement, where the employee already owns the policy, the employee would borrow from the policy's cash values in order to reimburse the employer's costs. In turn, the employer is no longer a collateral assignee. All rights belong to the employee alone. (Note: This effective arrangement is one that has come under fire from the regulators, perhaps more than other aspects of split-dollar funding, because of the "corporate responsibility" regulations,)
In either case, the insured can now pay future premiums from remaining cash values, from dividends, or both. Furthermore, because the employee now owns the policy outright, there is no taxable income resulting from the economic benefit formerly provided by the employer's share of premium payments. However, the employee will pay income taxes on any amount of cash value that exceeds the employee's contributions to this point.
Interestingly, if the total cash values accumulated in the policy at the time of rollout exceed the amount of premiums the employer has contributed, the IRS has ruled that the employer has a taxable gain even though the employer recovers no more than the premiums actually paid. For example, assume the employer has contributed premiums totaling $20,000 and the policy's cash value is $30,000 in the year of the rollout. This is a $10,000 taxable gain to the employer even if the employer takes a loan of only $20,000 to recoup its costs. However, the employer may also take a deduction equal to the amount of income on which the employee is required to pay taxes.
An alternate way to terminate the policy is called a spinout, under which the employer simply transfers all ownership rights to the employee without taking a policy loan. In effect, all premium contributions the employer has made and the cash values in the policy are a bonus paid to the employee.
A spinout results in taxable income for the employee to the extent cash values exceed the amount the employee has personally paid into the plan. The employer is then entitled to take a tax deduction for an equal amount. The deduction is permitted under a section of the tax code that permits such deductions as a business expense when the employer's contribution qualifies as bonus compensation.
At termination, split-dollar plans have sometimes been converted to key person insurance, with the employer gaining all ownership rights. Special care must be taken, however, to avoid transfer for value problems and resultant loss of tax exemption for the death proceeds. The only really safe circumstances under which a conversion of this sort can occur are when the insured under the split-dollar plan is an officer or shareholder. In this case, the proceeds retain the tax exemption.
1. Under a basicsplit-dollar life insurance plan
A. the employer pays the premium.
B. the employee pays the premiums.
C. both the employer and employee pay the premiums.
D. permanent insurance cannot be used.
2. Split-dollar insurance plans
A. may be provided discriminately.
B. must meet the requirements of the IRS.
C. must meet the requirements of ERISA.
D. must be provided on a non-discriminating basis.
3. The ownership arrangement under which a split-dollar policy is owned by the insured employee is the
A.. collateral assignment method.
B. endorsement method.
C. splitting the benefit method.
D. deferred compensation method.
4. A common premium-splitting arrangement is for one party to pay the portion of the premium equaling the annual increase in policy cash values. Under an unmodified plan, this party is typically the
A. employee.
B. employer.
C. employee’s spouse.
D. stock boy.
5. If the purpose of a split-dollar plan is to eventually fund deferred compensation for the employee, the ownership method should be the _________ arrangement.
A. collateral assignment .
B. employer pays all.
C. the fifth dividend option.
D. endorsement.
6. What variation on the split-dollar plan results in both the employer paying the premium and the employer receiving a partial tax deduction?
A. the employee & the employer pay equal shares of the premiums.
B. the employee pays the full premium.
C. bonus plan.
D. averaging.
7. What type of split-dollar feature operates to maintain a higher level of death proceeds payable to the employee’s beneficiary than the basic split-dollar arrangement?
. A. Table 2001 rates.
B. double bonus plan.
C. level employee contribution.
D. fifth dividend option.
8. The split-dollar that gives the policy’s cash values to the employee and the death benefit to the employer is called _______ split-dollar.
A. equity.
B. reverse.
C. mutual.
D. time value of money.
9. If no other tax complications come into play, the death benefits paid from a split-dollar plan are
A. taxable to the employer and the employee’s beneficiary.
B. taxable to the employee’s beneficiary only.
C. taxable to the employer’s beneficiary only.
D. not taxable.
10. In terminating a split-dollar plan while the employee is alive:
A. there are various ways to distribute the surrender values.
B. the employer must pay all outstanding premiums when due.
C. the employee receives nothing.
D. the insurance company pays the face value of the policy equally to the employer and the employee.
ANSWERS
1C 2A 3A 4B 5D 6C 7D 8B 9D 10A