How Do Split-Dollar Life Insurance Plans Work?
Split-dollar life insurance plans are not a type of life insurance policy, but rather, the term split-dollar life insurance plan refers to a contract between at least two parties that outlines how the following benefits and costs of a life insurance policy will be split and managed:
- The way a permanent life insurance policy gets paid––premiums split between two or more parties; and/or
- How the benefits of the policy are paid or shared this may refer to the cash values of the policy, death benefit and/or the beneficiary(ies)
Split-dollar life insurance plans may have the cost of the life insurance split between more than one party, where each pays their share of the premium cost. The same type of provision may be made in the split-dollar plan to assign beneficiaries and restrict or grant access to cash values. There are several types of split-dollar life insurance plans, for example:
- Between employer and employee
- For owners of companies
- Between shareholders and corporations
- There are also cases where they are set up between individuals; these can be referred to as "private split-dollar life insurance plans" usually between family members or by means of an Irrevocable Life Insurance Trust (ILIT).
For the purpose of this article, we will focus on the most common type of split-dollar life insurance plan, which is the split-dollar life insurance plan between an employer and an employee.
How Does It Work?
Split-dollar life insurance plans are often offered as part of an employee benefits package and can be a good strategy to offer perks or retain high-value employees. By offering to pay part of the cost of the life insurance policy with values, the employer provides a good benefit to their employee.
The employer and employee will sign an agreement that will outline how the cost of the life insurance premium will be shared between them, and who is eligible to cash in on the benefits of the policy, along with other terms.
What Are the Agreement Terms?
The terms of the split-dollar life insurance plan will cover all aspects of the policy payments, cash benefits, and "payouts." The split-dollar life insurance agreement is a legal document that should comply with applicable legal and tax regulations.
Among other considerations, the agreement should at least outline the following five aspects of the life insurance policy and split-dollar plan agreement:
- How much the employer and employee each agree to pay as their share and who is entitled to the various benefits (for example, death benefit and cash values).
- What conditions the employee must meet to remain eligible for the plan, this may include performance objectives and other terms.
- When the plan takes effect, and how long the plan will last.
- Conditions under which the plan may be terminated or changed. Including what happens if performance objectives are not met, or what happens if the employee is terminated or chooses to end their employment and how the plan will be terminated.
- Limits & beneficiaries: Cash value amounts, who the beneficiary is, death benefit amounts for the life insurance policy will all be defined.
Do You Take It With You If You Change Jobs?
The terms of a split-dollar plan often revolve around an employer and employee agreement. The terms outlined in the provisions of the split-dollar plan at the time of employment or contract negotiation provides for what happens at the termination of employment, whether voluntary or not. The split-dollar life insurance plan should be seen as an employee benefit. In most cases, the employer would not continue to split the cost of a life insurance policy after employment has ended. You may have the option to maintain the plan at your cost, depending on the insurance provider and terms of your policy.
Ask about this aspect of a split-life insurance plan if you are signing up for one or have one.
Depending on the type of agreement and conditions of your split-dollar plan, there can be several benefits.
- Sharing the cost of insurance gives a low-cost option for life insurance for the employee. Sometimes split-dollar plans may even be "employer pay all." Corporate dollars are paying for the plan, instead of you.
- Having the life insurance policy may act as a way to prevent becoming uninsurable in the future if you become sick during the time when you are insured on the plan.
- Saving money on future life insurance. You may benefit from maintaining the insurance based on the rate of insurance at the age you were originally insured at, not the age when you retire or leave employment. If there is an option to buy out the plan via a "rollout," or convert the plan, depending on the initial agreement options.
- Possible access to cash values or borrowing from the life insurance policy.
- Minimizing gift and estate taxes, as well as other potential tax benefits depending on how your plan is written up.
Split-dollar life insurance plans can have many benefits but are complicated because of the flexibility and vast range of options that could be written into the agreements. It is always advisable to seek the advice of tax attorneys, licensed insurance representatives and/or a financial planner if you need help understanding the implications of the split-dollar life insurance plan for your situation. Split-dollar plans should always be written up and reviewed by a qualified professional, such as an attorney to ensure they adhere to legal requirements and protect your interests.