Usually, life insurance is something purchased by an individual to protect loved ones. However, in many cases, insurance coverage can also be used as a means of providing additional employment benefits. Although group insurance is the most common form of employer-sponsored plans, split-dollar life insurance is another option for executives and high-value employees. In this article, we want to provide some background into split-dollar insurance, how it works, and how it's taxed. This way, if your clients get into a plan, they know what to expect.
What is Split-Dollar Life Insurance?
Technically speaking, this term refers to an arrangement between two or more parties, not a specific type of life insurance coverage. Split-dollar refers to the fact that both parties split the costs and benefits of a plan. Although this arrangement doesn't have to be between employer and employee, that is most often the case. There are two ways that coverage can be divided:
- Economic Benefit Arrangement: the employer is the policyholder and pays the premium. The employer also assigns various rights of the policy to the employee
- Loan Arrangement: in this case, the employee is the policyholder, although the employer still pays the premiums. The employee then gives interest back to the employer throughout the life of the plan. This interest is based on premium payments, which are provided as a loan each year.
For a while, this type of insurance arrangement was popular for businesses as a tool for incentivizing high-level employees. Here is how both methods are taxed now, as well as the benefits of these plans.
- Economic Benefit Taxation: Taxation under this regime is based on the value provided to the employee. Essentially the employer is deemed to be providing to the employee a benefit in the form of the value of the death benefit protection. The benefit is calculated based on the cost of a 1 year term for the death benefit received.
- Loan Arrangement Taxation: if the employee pays the market interest rate on the loans (i.e., premium payments) from the company, he or she won't get taxed. However, if the employee pays less than the market rate, the remaining balance is taxed by the IRS. The primary reason to go with a loan arrangement is if the applicable federal rate (AFR) is below the market. This way, the employee doesn't have to pay any taxes as well as lower interest.
Why Get Split-Dollar Life Insurance?
Split-dollar provides a tax-free pool of money to executives and business owners. Also, corporate executives can use company money to pay for life insurance, rather than out of pocket. So, if your clients can receive any of these benefits, split-dollar life insurance may be a feasible option.
Contact Advisor's Resource Today
These arrangements can be somewhat complicated, so if you need assistance navigating them, contact us today. We can help you help your clients make the right decision for themselves and their families.