1. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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?

2. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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?

3. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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?

4. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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

5. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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 3.10 - 20 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

6. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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

7. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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

8. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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

9. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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

10. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company10 Endorsement method –Employer owns policy –Employer responsible for premium payment –Employer receives death benefit = premiums paid Design Features: Policy Ownership

11. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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

12. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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

13. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, 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

14. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company14 1.Before September 18, 2003 –Taxed under “economic benefit” theory –Amount of economic benefit received by employee each year was determined by using IRS table that valued the pure insurance coverage for the employee Tax Implications

15. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company15 2.After September 18, 2003 have two mutually exclusive regimes for taxing split dollar arrangements - economic benefit regime - loan regime Tax Implications

16. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company16 Economic benefit regime applies to - endorsement type plans - collateral assignment plans that are not equity-type plans Employee must count value of life insurance or other benefit provided under a split dollar plan as additional taxable income Tax Implications

17. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company17 Loan regime applies to - collateral assignment equity-type plans Employer paid premiums treated as loans from employer to employee If arrangement carries no stated interest rate, loan considered a “demand loan” and taxed under IRS code Sec. 7872 Tax Implications

18. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company18 Rollout rules (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

19. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company19 Death benefits –Generally income tax free –Tax-free nature of death proceeds lost if policy transferred for value except for transfer of policy to insured to partner or partnership of insured to corporation of which insured is shareholder or officer in which transferee’s basis determined in whole or part by transferor’s basis Tax Implications

20. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company20 To avoid potential transfer for value situations in split- dollar plans –Do not start plan by transferring existing corporate-owed key employee policy to 3 rd party beneficiary –Do not start plan by transferring an employee-owned policy to the corporation unless employee is shareholder or officer –At plan termination, do not transfer corporation’s interest in policy to 3 rd party beneficiary Tax Implications

21. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company21 Gift taxes –May be federal gift tax imposed on premiums if person other than employee owns insurance policy used in split dollar plan –May be able to avoid gift tax if qualify for annual gift tax exclusion ($13,000 in 2011, indexed) Tax Implications

22. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company22 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

23. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company23 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?

24. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company24 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?

25. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company25 Employee Benefit & Retirement Planning True or False? 7.In an standard split dollar arrangement, the employee’s outlay is relatively low in the initial years of the plan. 8.The purpose of an offet plan is to reduce the employee’s income tax cost for the plan. 9.Recently, significant changes have occurred in the tax laws governing split dollar life insurance. 10.Split dollar plans are exempt from ERISA regulations.

26. Split-Dollar Life Insurance Chapter 42 Employee Benefit & Retirement Planning Copyright 2011, The National Underwriter Company26 Is a split dollar arrangement a useful compensation technique for a partner, proprietor, or shareholder employee of an S corporation? Discussion Question