How Split-Dollar Life Insurance Works

Life insurance can be a foundational financial planning tool for many, helping to protect loved ones and, with the right policy type, build cash value. This is why some employers offer a workplace benefit called split-dollar life insurance. Under these agreements, employers pay premiums to make it easier for employees to gain coverage. Such a benefit can attract and retain key employees, making it an excellent potential investment for many employers. This article will explain how split-dollar life insurance works, its benefits, and a few alternative policy options.

What is split-dollar life insurance?

Split-dollar life insurance is a contract where an employer and employee agree to share a life insurance policy’s costs and benefits. This agreement specifies each party’s rights and responsibilities for a shared policy in a written contract. It includes the agreement's term length, how the agreement ends, and the employee’s responsibilities for maintaining coverage. It can also detail how coverage can change if the employee leaves the company or fails to hit agreed-upon targets. Companies often use split-dollar life insurance to help attract and retain important or high-level employees, such as executives or managers.¹

Who owns split-dollar life insurance?

The employer or employee can each own the life insurance policy. The policy is never jointly owned. Each arrangement has a unique name and differs in features and operation:¹

Economic benefit regime

In an economic benefit regime, or economic benefit arrangement, the employer owns the policy. They pay policy premiums and decide on the employee’s rights and benefits regarding the policy, including the death benefit portion and access to cash value. Meanwhile, the employee in the agreement designates beneficiaries to receive some of the death benefit payout if the employee passes away while the policy is active. Employees may be taxed on the economic value of this policy, which is calculated each year by the IRS.²

Loan regime

Under a loan regime, the employee owns the life insurance policy, but the employer pays policy premiums. For tax purposes, premium payments are treated as loans to the employee each year. The employer must charge a sufficient interest rate based on the Applicable Federal Rate (AFR).² However, this allows for flexibility in loan structure. The employer can structure this as a term or demand loan.

To make the agreement fair for both sides, the employee gives the employer an interest in the policy’s death benefit and cash value through a collateral assignment agreement. This agreement restricts certain aspects of the policy. A loan regime can be more complicated than an economic benefit regime due to the complexities of structuring and managing the loan and its tax implications.

Benefits of split-dollar life insurance

Split-dollar life insurance can offer numerous benefits to employers and employees:

Your employer helps make premium payments

One of the most helpful aspects of split-dollar life insurance is that your employer covers the cost of premiums. This can make it easier to get a basic level of coverage and make larger coverage amounts more accessible. For employers, split-dollar life insurance can be an attractive benefit for persuading high-quality candidates to sign on or current employees to continue working for their company.

Low interest rates

Loan regime agreements may come with low interest rates, especially if the economy’s prevailing interest rates are low relative to the AFR. These rates can be lower than rates obtainable through traditional borrowing methods. This gives employees a more affordable way to get coverage without paying now and repay the debt they owe later. It also lets them maximize their cash value since they don’t have to pay the premiums necessary to grow coverage right away. Additionally, employers can more easily offer this benefit to employees while fitting it into company budgets.

Tax benefits

Employers generally can’t take tax deductions for premiums paid under a split-dollar agreement. However, they may be able to deduct cash value provided to an employee. Meanwhile, the employee may not owe taxes on the interest if it is at or above the AFR.