Split-dollar life insurance

Another way to reward key employees

The arrangement under which an employer and an employee share the costs and benefits of a cash value life insurance policy on the employee's life is known as split-dollar life insurance. Given that SDLI arrangements are not subject to the antidiscrimination rules applicable to qualified retirement and other types of benefit plans, such arrangements give employers added flexibility in rewarding key personnel and shareholder­owners; in addition, these arrangements also are advantageous to employees, because they cost less than personally owned life insurance.

As a method that divides the economic benefits and burdens of life insurance between a company and an employee, SDLI allows the company to subsidize (in whole or in part) the employee's coverage. When the employee dies or the policy is terminated, the employer receives some (or all) of the policy's cash surrender value (depending on how the premium payments were arranged) and the employee's estate receives the balance.

Premiums. In most cases, the employer pays all the premiums and the insured is treated as receiving taxable income. Under the two most typical arrangements, the employer's premium is equal to the annual increase in the policy's cash surrender value (the employee pays the balance) or the employee contributes the cost to buy a one-year term policy of equivalent coverage (the employer pays the balance of the premium).

Benefits. When an insured employee dies, the split of benefits usually is determined by the interests in the arrangement. The employer's portion can be a return of premiums paid, the policy's cash surrender value at the date of death or the greater of the two. The employee's estate then receives the balance of the payout.


Ownership of the Policy
SDLI can be structured in several ways, each of which may affect who is considered the SDLI policy's owner.

Under the collateral assignment method, the insured or a third party owns the policy; the owner collaterally assigns rights in the policy to the employer. These rights may vary considerably, from virtually all rights to a "bare bones" collateral assignment.

Under the endorsement method, the employer owns the policy, and the employee's rights are contained in an endorsement filed with the insurer. In a traditional endorsement policy, the employee's sole right is to name the beneficiary of the proceeds in excess of the employer's interest in such proceeds.

Under the undocumented method, a contractual arrangement with the employee protects the employer's advances. Under the coownership method, the employee (or other owner) directly owns a share of the policy's cash surrender value.


Estate Tax Issues
Ownership. To be excludable from an estate, the proceeds cannot be receivable by or for the benefit of the insured's estate, and the decedent may not have any incidents of ownership in the contract.

If the insured individual does not retain any incidents of ownership in a policy, the proceeds should not be includable in his or her estate. However, ownership of a policy by a corporation that is more than 50% owned by the insured or owned jointly by the individual and another may present difficulties. Similar problems may arise with stock owned by spouses or other family members, as ownership may be attributed to the insured.

Three-year rule. If an insured dies within three years of transferring ownership in a policy on his or her life, the proceeds are includable in his or her estate. This rule also may have to be considered when a controlled corporation owns a policy on the individual's life and the insured disposes of sufficient shares to reduce his or her voting interest in the corporation to less than 50%.


Imputed Interest
There may be imputed interest issues. If an SDLI arrangement is characterized as a series of interest-free or below-market-interest-rate loans, an employee would have to report the forgiven interest as income. On the other hand, such advances and other loans from an employer to an employee would have to exceed $10,000 before resulting in interest income.

For a discussion of SDLI, see "Is Split-Dollar Life Insurance Still a Fringe Benefit?" by Robert Swanson, in the January 1998 issue of The Tax Adviser .

—Nicholas Fiore, editor
The Tax Adviser



 

©1998 AICPA

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