SPLIT DOLLAR INSURANCE:

(California Broker) Most insurance is purchased directly by an individual or company

and payments are made in full by the respective parties. However, the split dollar policies used in business provide for two parties to divide the payments, rights and responsibilities.

The respective parties agree to share the policy's premiums and to apportion the rights to the policy's living values and death benefits. In a normal endorsement method, the employer is the policy owner and endorses or grants to the insured (usually an executive/highly compensated employee) the rights to designate a beneficiary for his/her agreed upon portion of the death proceeds. The ER has rights over the cash values and dividends. Since the policy is initially owned by the corporation, when the split dollar agreement is terminated and the endorsement released, it is NOT portable to the executive without tax reprocussions (the cash value). Under the collateral assignment method, the policy is initially owned by the executive and as such, when the agreement is terminated, the policy is retained by the employee without tax problems. With this method, the executive subordinates a lien by the corporation to certain rights- usually premiums advanced. Upon termination, the corporation can withdraw its interest or get reimbursement of the premiums from the employee.

Irrespective of the potential tax problem at termination, there is another tax issue when the ER pays the entire premium. IRS Rev. Rul. 64-328 inputs an economic benefit to the extent that the EE must either include the economic benefit in his/her taxable income or contribute it as premium to the policy. The amount is determined by the P.S.58 rates for term insurance (though one can use the insurance company's annual renewable term rates if lower). The total economic benefit is determined by multiplying the thousands of dollars of coverage by the P.S.58 rates. Lastly, if the corporation is the beneficiary of the policy, it cannot deduct any of the premiums as a business expense. So what is the big deal with all this? Simple- even with the P.S.58 economic benefit costs, the EE is getting significant cash value or death benefit for his beneficiaries as a "bonus" by the EE to stay with the company. Many variations are used.

REVERSE SPLIT DOLLAR: The essence of this arrangement follows the basic concepts above but the EE and ER's positions are reversed. The EE is the insured and will own and control the policy including the cash value. The ER will have a limited right to name the beneficiary of the amount of the death benefit in excess of the EE's death benefit under the plan. For tax reasons, the beneficiary of the ER's portion should always be the ER. One difference under this plan is that at rollout there is no taxable problem for the EE since the ER's premiums only purchased the right to name the beneficiary of the "at risk" portion of the policy while the agreement is in effect. At termination, the ownership of the policy is fully with the EE. Another advantage of this reverse is that since the ER is paying the value of the economic benefit each year, the ER will pay a greater share of the annual premium each year. This lowers the cost of acquiring a permanent life insurance policy for the key employee.

SPLIT DOLLAR INSURANCE (1995) : This is normally considered for businesses but, due to recent tax changes, even has a greater focus. Essentially, it is a method of putting extra money away tax deferred in a whole or variable life insurance product which is paid in good part by the employer- who wants to provide an extra incentive to keep a valued employee from moving elsewhere. When the plan is terminated, the company gets back(normally) the premiums paid- but the account has grown much larger than that and the employee gets to keep the rest. In the interim until retirement, the employee has a substantial life insurance policy. Let's take an example from an insurance "expert" on a 44 year old healthy non smoking male and a policy valued at $1.8 million with premiums of $50,000 annually. The EE pays only $1,900 (the amount of what would have been term insurance) and the ER pays the rest of $48,100. When the EE retires at 65, the policy has grown (due to cash buildup) to $3.2 million. In order to pay back the ER, the policy is split in half. The $1.6 million policy has cost the EE about $75,000 (the amount of term insurance has gone up each year as the EE has gotten older) but the remaining cash value, which can be taken out as a loan, could allow loans of $65,000 a year for 17 years. The estimates were drawn at 9.3%- which I think is too high and something more like 7% is more feasible now as a projection. Nonetheless, it can work to provide more funds for an EE- that is as long as Congress allows this type of plan. Frankly, the whole setup has little to do with life insurance- just tax deferred growth. It's not taxed currently- or at all if taken out as a loan- so the rest of us are paying for this benefit. Fair? Not really, but it does exist and is currently legal for those that can take advantage of it. And even if Congress does change its mind, older policies will undoubtedly be grandfathered.

SPLIT DOLLAR: 1996 This commentary is rather obscure and deals with corporations and collateral assignments of insurance. Generally, a split dollar policy is where an employer buys a cash value policy for an employee (usually the highly compensated who the ER is trying to retain on a long term basis) and where the EE may pay some portion. Since the benefit goes to the EE, he or she will be taxed on the pure "cost" of the coverage- usually defined as the IRS PS 58 tables or the life insurance company's alternatives rates which tend to be lower- minus any portion of the premium the EE pays. Now to complicate the matter, recognize that when the employee dies, the policy will be included in his/her estate for estate tax purposes. And since we are usually talking about heavy hitters, the insurance proceeds may be subject to a tax as high as 55%. This is normally the situation where the deceased is the insured and has incidents of ownership. (Incidents of ownership include the right to change a beneficiary, right to take loans, surrender the policy, etc.) Where the decedent is the controlling shareholder, a corporations incidents of ownership in regards to owning a policy on the shareholders life will be attributable to the controlling shareholder. If the corporation has an incident in ownership in the policy where the death proceeds are payable to someone OTHER than the corporation, then the shareholder will be required to include the proceeds in his or her estate. Any attempt by the shareholder to assign his or her rights to a third party will be void if the corporation retains any incidents of ownership. Split dollar agreements make the agreement more complicated because both the ER and EE share in the costs and benefits of the policy. However, it apparently is possible to draft an agreement under certain conditions that will avoid the scrutiny of the IRS and where the proceeds will remain out of the decedents estate.

Wasn't that fun? Of course not. But it does help to document how difficult insurance planning can be. It's not only the law, but the fact that none of the insurance companies ever really provide the necessary documentation to understand exactly what their particular policy will do versus another.

"New Split-Dollar Life Insurance Rates" (You need to sign up at  http://www.pgdc.net)

The Internal Revenue Service issued their long-awaited position on split-dollar life insurance arrangements in 2001. In addition to the full text of Notice 2001-10, PGDC Editors have included in their commentary a chart setting  forth the new rates (Table 2001), and comparing them with the old rates (P.S. 58).

Reverse split dollar (National Underwriter) Joseph F. Stenken, J.D., CLU, ChFC (2002)

After years of silence regarding reverse split dollar, the Service recently issued a notice on the valuation of current life insurance protection under split dollar life insurance arrangements. The notice will have a direct affect on reverse split dollar, and some commentators have said that it will cause the end of the usefulness of reverse split dollar arrangements and also affect reverse split dollar arrangements that were entered into before the notice was issued.

According to the Service, under certain split dollar arrangements a party who holds the right to current life insurance protection will use inappropriately high current term insurance rates, prepayment of premiums, or other techniques to give policy benefits other than current life insurance protection to another party in the arrangement. The use of these techniques to understate the value of these other policy benefits distorts the income, employment, or gift tax consequences of the arrangement and is not permitted by any published guidance.

According to the notice, a party to a split dollar arrangement may use Table 2001 or the insurer's rates only for the purpose of valuing current life insurance protection when the protection is conferred as an economic benefit by one party on another party, determined without regard to consideration or premiums paid by the other party. Thus, if one party has the right to current life insurance protection, neither Table 2001 not the insurer's rates can be used to value that party's insurance protection for purposes of establishing the value of policy benefits to which another party may be entitled.

The notice provides one example where the premium rates are used properly and one where they are not. In the first example, a donor is assumed to pay the premiums on a life insurance policy that is part of a split dollar arrangement between the donor and a trust, with the trust having the right to current life insurance protection. The current life insurance protection has been conferred as an economic benefit by the donor on the trust and the donor is permitted to value the life insurance protection using either Table 2001 or the insurer's lower term rates.

However in the second example, if the donor or the donor's estate has the right to the current life insurance protection, neither Table 2001 nor the insurer's lower term rates may be used to value the donor's current life insurance protection to establish the value of economic benefits conferred upon the trust. Results will be similar if the trust pays for all or a portion of its share of benefits provided under the life insurance arrangement.

The notice does not contain an effective date, which indicates that the Service does not consider it “new” guidance, but a restatement of current law. If that is the case, it will affect reverse split dollar arrangements that were in place before the notice was issued.