Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company1 An arrangement to share costs and benefits of a life insurance policy –typically between employer and employee, but can be used by others –can split premiums, death benefits and/or cash value, dividends, or ownership What is it?

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company2 When employer wants : 1.To provide executive with low cost and low outlay life insurance benefit 2.An alternative to insurance-financed nonqualified deferred compensation plan for providing pre-retirement death benefit When is it indicated?

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company3 When employer wants : 3.To provide exclusive executive fringe benefit 4.To establish market for stock facilitate cross-purchase buy-sell enable non-stockholding employee to effect a one-way stock purchase at death of existing shareholder What is it indicated?

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company4 1. Executive can use employer funds to receive current benefit with minimal tax cost 2.Employer’s outlay fully secured 3.Can customize plan to meet specific objectives Advantages

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company5 1.No tax deduction for employer’s share of premium payments 2.Employee pays income tax each year on current cost of life insurance protection under plan years before policy cash values are sufficient to maximize plan benefits 4.Must terminate plan when employee near age 65 5.Unfavorable tax treatment under new regulations Disadvantages

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company6 4 major categories 1.Classic or standard split dollar plan 2.Level premium plan 3.Employer pay all 4.Offset plan Design Features: Premium Cost Split

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company7 Purpose – reimburse employer for share of premium outlay when employee dies or terminates plan Design Features: Cash Value and Death Proceeds Split

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company8 Commonly used cash value / death proceeds split arrangements: –employer share is GREATER of: (1) aggregate premiums it has paid OR (2) policy cash value Design Features: Cash Value and Death Proceeds Split

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company9 Commonly used cash value / death proceeds split arrangements: –employer can only recover up to amount of aggregate premiums paid OR –employer entitled to entire cash value Design Features: Cash Value and Death Proceeds Split

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company10 Endorsement method –Employer owns policy –Employer responsible for premium payment –Employer receives death benefit = premiums paid Design Features: Policy Ownership

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company11 Endorsement method advantages 1.Employer has greater control over policy 2.Simple installation and administration 3.Avoid formal arrangement that might be deemed a loan for tax and legal purposes 4.Can use existing key employee policy without ownership change Design Features: Policy Ownership

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company12 Collateral Assignment –Employee or 3 rd party is policy owner –Employee or 3 rd party responsible for premium payment –Employer makes interest free loans = premium –Policy assigned as collateral to employer –Employer recovers aggregate premium payments from policy proceeds as collateral assignee at death of employee –Employee’s beneficiary gets remaining benefits Design Features: Policy Ownership

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company13 Collateral assignment advantages –Better protection for employee and employee’s beneficiary –Easier to implement using existing policies owned by employee Design Features: Policy Ownership

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company14 1.Before September 18, 2003 –Employer could not deduct any part of premium payment –Lacking clear rules, practitioners took position that either no tax liability for increases in employee’s share of cash value or taxable only when plan terminated and policy ‘rolled out’ to employee Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company15 2.After September 18, 2003 Split dollar life insurance defined as “ any arrangement between an owner and a non-owner of a life insurance contract” that also satisfies the following three criteria: Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company16 3 Criteria for Defining Split Dollar Life Insurance: 1.Either party pays all or a portion of the premiums, including a payment by means of a loan secured by the life insurance contract. 2.One of the parties can recover a portion of the premiums paid from the contract (or payment is secured by the contract). 3.The arrangement is not part of a Section 79 group-term life insurance plan unless the plan provides permanent benefits. Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company17 Two mutually exclusive regimes for taxing split dollar life insurance –economic benefit regime –loan regime Must ascertain owner of policy to determine which regime applies Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company18 Ownership rules –Named policy owner generally treated as such under regulations –If two or more owners all have incidents of ownership with respect to an undivided interest in the contract, each treated as owner of separate contract –If two or more owners and not all have incidents of ownership, first named owner considered owner for purposes of regulations Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company19 Economic benefit treatment Employee must count value of life insurance or other benefit provided under a split dollar plan as additional taxable income Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company20 Rollout (transfer of contract) –Transfer of contract to non-owner generates income for non-owner equal to fair market value of contract less various sums paid by non-owner to transferor or taken as income by the non-owner –If contract subject to substantial risk of forfeiture, employee can delay tax to sometime after the rollout Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company21 Loan treatment –Default treatment of plans that do not meet economic benefit regime requirements –Generally, loan amount is deemed taxable income to recipient (usually employee), specific details governed by tax law and loan characteristics such as interest rates or date loan payable Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company22 Effective date Split Dollar regulations apply to arrangements entered into after 9/17/2003 and arrangements materially modified after 9/17/2003. “Materially modified” is not defined, but a list is provided to show what is not a material modification exchanges are not on that list. Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company23 3.Split dollar life insurance death benefits income tax free –employer’s share –employee’s beneficiaries share –note: some transfers of insurance policies are exempt from transfer for value rules, some are not Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company24 4.Incidents of ownership affect estate tax liability –if employee had no incidents of ownership, death benefit excluded from employee’s estate for estate tax purposes unless policy proceeds payable to estate –if employee is controlling shareholder, corporation’s incidents of ownership in policy will be attributed to controlling shareholder, death proceeds included in employee estate Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company25 5.May be federal gift taxes to pay if someone other than employee owns insurance policy used in split dollar plan Tax Implications

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company26 Split dollar plans are ‘welfare benefit’ plans under ERISA –must have written document, “named fiduciary,” and formal claims procedure –can escape ERISA reporting and disclosure if is ‘insured’ plan maintained for ‘a select group of management or highly compensated employees’ –if cover more than select group, must provide SPD ERISA Requirements

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company27 1.Split dollar plans are best suited for executives in their late 50’s and early 60’s. 2.In most split dollar plans, the employer’s outlay is fully secured at all times. 3.The employer receives a tax deduction for its share of premium payments under a split dollar plan. True or False?

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company28 4.Under the classic or standard split dollar plan, the employer and employee split the cost of the life insurance premium equally. 5.An employee who terminates employment before a split dollar plan matures can be held personally responsible for reimbursing employer for aggregate premiums paid. 6.The employee owns the policy under the endorsement method of policy ownership. True or False?

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company29 7.Recently, significant changes have occurred in the tax laws governing split dollar life insurance. 8.Split dollar plans are exempt from ERISA regulations. True or False?

Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2009, The National Underwriter Company30 Is a split dollar arrangement a useful compensation technique for a partner, proprietor, or shareholder employee of an S corporation? Discussion Question