What is a split dollar life insurance plan?

What is a Split Dollar Life Insurance Plan?

A split dollar life insurance plan is a financial arrangement where two parties share the costs and benefits of a life insurance policy. Typically, this involves an employer and an employee, but it can also be used in other situations, such as between business partners or family members. The plan’s primary purpose is to provide the employee with life insurance coverage while allowing the employer to recover a portion of the premiums paid.

How Split Dollar Life Insurance Works

The core concept of a split dollar plan is the division of premium payments and death benefits between the employer and employee. Here’s a breakdown of how it works:

  • Premium Split: The employer and employee agree on a specific percentage or formula to split the premium payments. For example, the employer might pay 75% of the premium, while the employee covers the remaining 25%.
  • Death Benefit Split: Upon the insured employee’s death, the death benefit is divided between the employer and the beneficiary (usually the employee’s family). The employer receives a portion of the death benefit equal to the premiums they paid, while the beneficiary receives the remaining amount.

Types of Split Dollar Life Insurance Plans

There are two main types of split dollar life insurance plans:

1. **Traditional Split Dollar Plan:**

In this arrangement, the employer pays a portion of the premium and receives a portion of the death benefit equal to the premiums they paid. The employee pays the remaining premium and receives the remaining death benefit. This plan is typically used for key employees who are essential to the company’s success.

2. **Collateral Assignment Split Dollar Plan:**

This plan involves the employee owning the policy and assigning a portion of the death benefit to the employer as collateral for the premiums they paid. The employer receives a portion of the death benefit equal to the premiums they paid, while the employee’s beneficiary receives the remaining amount. This plan is often used when the employer wants to avoid owning the policy directly.

Advantages of Split Dollar Life Insurance

Split dollar life insurance offers several advantages for both employers and employees:

For Employers:

  • Tax Advantages: Employers can deduct the premiums they pay as a business expense, potentially reducing their tax liability.
  • Retention of Key Employees: Split dollar plans can be a valuable tool for retaining key employees by providing them with a significant life insurance benefit.
  • Business Continuity: In the event of a key employee’s death, the employer can use the death benefit to cover expenses, such as replacing the employee or paying off debts.

For Employees:

  • Affordable Life Insurance: Split dollar plans can make life insurance more affordable for employees, especially those with limited financial resources.
  • Significant Death Benefit: Employees can obtain a substantial death benefit that can provide financial security for their families.
  • Tax-Free Death Benefit: The death benefit received by the employee’s beneficiary is generally tax-free.

Disadvantages of Split Dollar Life Insurance

While split dollar life insurance offers several benefits, it also has some potential drawbacks:

  • Complexity: Split dollar plans can be complex to set up and administer, requiring careful planning and legal advice.
  • Tax Implications: The tax implications of split dollar plans can be complex and vary depending on the specific plan structure.
  • Potential for Abuse: Split dollar plans can be misused if not properly structured and monitored.

Case Study: Split Dollar Life Insurance for a Small Business

Imagine a small business owner, Sarah, who wants to provide life insurance coverage for her key employee, John. Sarah’s business is heavily reliant on John’s expertise, and his death would significantly impact the company’s operations. Sarah decides to implement a split dollar life insurance plan with John.

Sarah agrees to pay 75% of the premium for a $1 million life insurance policy on John’s life. John pays the remaining 25%. Upon John’s death, Sarah’s business will receive 75% of the death benefit, while John’s family will receive the remaining 25%. This arrangement provides John with a substantial death benefit for his family while allowing Sarah to recover a portion of the premiums she paid.

Conclusion

Split dollar life insurance plans can be a valuable tool for both employers and employees. They offer a way to provide employees with affordable life insurance coverage while allowing employers to recover a portion of the premiums paid. However, it’s crucial to understand the complexities and potential drawbacks of these plans before implementing them. Consulting with a financial advisor and tax professional is essential to ensure that the plan is structured appropriately and meets the specific needs of both parties involved.

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