Employer Sponsored Split Dollar Techniques

Employer Sponsored Split Dollar Techniques – Split Dollar refers to a “Method” of purchasing life insurance which determines how the premium payments are paid and by whom, as well as how the benefits of the policy itself will ultimately be divided between two entities, either at retirement, or at the death of the insured. Typically, this pre-determined split is between an employee and his or her employer, although the arrangement can also be made between two individuals or between an individual and a trust. The advantage of the Split Dollar Technique is that it is extremely attractive to the employee who receives valuable life insurance protection at a lower cost than if purchased on a personal basis. The employer can make use of a cost-effective technique that enables it to attract, incentivize, and retain their key employees by way of two optional strategies that each have unique advantages.

Economic Benefit Regime (EB) vs. Loan Regime (L) – refers to two types of split dollar arrangements as outlined in Treasury Regulations issued in September 2003.

The Economic Benefit Regime (Regulation 1.61-22) is where the employer is the owner of the policy and pays the policy’s premium. This arrangement is generally known as the “endorsement method”, however the Economic Benefit Regime can also apply in situations where the employee owns the policy but does not have any equity interest in accruing cash values of the policy (also known as a “non equity” arrangement. The employee typically will include just the reduced “term cost” of the insurance in his/her taxable income, which is typically the annual value of the death benefit payable to the employee’s beneficiary under IRS Table 2001. This type of split dollar arrangement allows the employee to name a personal beneficiary for his/her share of the death benefits. With regard to distribution of such policy benefits, the employer’s interest in the policy is the greater of the premiums paid by the employer or the policy’s cash value, and the employer is entitled to be paid these amounts from cash values at retirement or from the ultimate death benefit of the policy. The employee’s beneficiary is entitled to the death benefit in excess of the employer’s interest in the policy. A significant benefit to the employee is the reduced cost of the insurance that is picked up in the employee’s income in comparison to the death benefit ultimately received by the employee’s beneficiary.

The Loan Regime (Regulation 1.7872-15) - is where the employee or a trust established for the employee, is the owner of the policy. In this arrangement, also known as the “collateral assignment” method, the employee names a personal beneficiary, but assigns policy benefits to the employer as collateral in order for the employer to advance the premiums. The policy is paid by the employee through a series of loans that are made by the employer to the employee at a stated interest rate which is typically at or above the published applicable federal rate in effect during the month premium loans are made. In this scenario, all equity in the policy in excess of the loan amount accrues to the “owner employee (or trust)”. For this reason, the Loan Regime arrangement is sometimes termed “Equity split dollar” because the employee can receive equity in the cash value that exceeds the premium loans and interest that are reimbursed to the employer from any cash value proceeds or death benefit. At the employee’s death, the employee’s beneficiary receives the death benefit in excess of the employer’s interests in the policy, which again is typically the excess over the loan amount plus any accrued interest.

In reviewing the two regimes, it would appear that the economic benefit regime would favor the employer should a policy perform well and accrue benefits in excess of the premiums paid, which would later be paid to the employer providing a greater share of the death benefit. Generally, any term cost premiums paid by the employer on behalf of the employee are deductible by the employer and includable in the employee’s income, or considered income to the employer if paid by the employee or reimbursed to the employer. Generally, with regard to estate taxes, any incidents of ownership in the policy held by the insured will require inclusion of death benefits in the insured’s estate, unless a third party such as an Irrevocable trust becomes the policyowner. Death benefits are not taxable to the employee’s beneficiaries, however to preserve this non-taxable event, it is imperative that the employer provide written notice in the agreement with the employee of the employer’s intention to purchase life insurance on the employee and to make sure the employee provides a written consent for this purchase. Significant benefits can accrue regardless of which regime is in place, however, the loan regime may sometimes provide greater lifetime benefits to an employee when the arrangement is terminated at retirement since greater cash values may be available to provide for employee retirement distributions.