Split-dollar life insurance: How it works

What is a split-dollar life insurance agreement?

As the name suggests, a split-dollar life insurance agreement is an agreement to share a life insurance policy between two or more parties. Typically, the parties agree on how premiums will be paid and how the policy’s benefits will be divided. Businesses have long used them in compensation packages as a desirable benefit for high-value employees, as well as for helping the company cover losses should something unexpected occur.

For example: Let’s say that you’re a large corporation. What would happen financially if your CEO died suddenly? Likely, there would be a significant impact on the organization’s bottom line. As you deal with the sudden departure and work to find a replacement and transition to new leadership, millions of dollars could be at stake. If the company is publicly traded, that impact is likely to be felt immediately in the stock price.

Split-dollar plans can help address this type of risk, but they can serve other purposes as well.

It’s not actually life insurance

Split-dollar plans are not a type of life insurance. Rather, they are an agreement that specifies how two or more parties share the costs and benefits of a life insurance policy.

They’re mostly used to protect businesses

Split-dollar plans are usually used to help businesses address the financial risk of losing a high-value employee unexpectedly. Depending on the arrangement, the employer may pay some or all of the premiums and the benefits are split between the employer and the family of the deceased. Both sides benefit from the agreement, but only one life insurance policy is needed.

It’s still used—but is less common now

Federal tax rules governing split-dollar arrangements changed in 2003, which led to them not being used as frequently as before.

How a split-dollar life insurance agreement works: A step-by-step guide

Since split dollar agreements involve multiple parties, the transaction is a bit more complicated than an individual life insurance contract. In most cases, there are six essential steps.

1. Select the policy.
2. Decide who owns it.
3. Determine how premiums are paid (and who pays them).
4. Decide how the death benefit and cash value are split.
5. Identify the applicable tax status.
6. Specify how and when the split-dollar agreement will end.

Let’s look at each of these steps a little more closely and explore some of the key factors to consider.

Start by selecting a permanent life insurance policy

First, the parties should select a permanent life insurance policy, such as whole life insurance. It provides a guaranteed death benefit,¹ coverage that will last a lifetime as long as premiums are paid when due, and premiums that will never change. Permanent life insurance policies also provide cash value—funds that can be accessed while the insured is still alive.²

Decide who owns the policy: the employer or employee

Next, the parties determine who will be the legal owner of the life insurance policy, which affects who can exercise rights under the contract and can have important tax consequences. In an employer-employee arrangement, for example, the employer may own the policy and provide certain benefits to the employee, or the employee may own the policy while the employer helps fund the premiums. In estate planning arrangements, ownership may instead rest with an individual or an irrevocable life insurance trust (ILIT).

Determine how premiums are paid—and who pays them

The agreement should clearly establish who is responsible for paying the policy premiums and how those payments will be treated. One party may pay the entire premium, the parties may divide the cost, or one party may advance funds that are ultimately expected to be repaid from the policy’s cash value or death benefit. The agreement should also address how future premium requirements will be handled and what happens if the policy requires more funding than originally anticipated.

Decide how the death benefit and cash value are split

A defining feature of a split-dollar arrangement is that the parties agree on how the policy’s benefits will be divided. The agreement may provide one party with the right to recover premiums paid, a specified amount, or another defined interest from the policy’s cash value or death benefit, with the remaining amount going to the other party or designated beneficiaries. It should also specify each party’s rights to cash value while the insured is alive, including any permitted withdrawals, loans, or other access to policy values.

Identify the applicable tax treatment

Split-dollar life insurance taxation depends on who owns the policy—and who pays the premiums. When the employee owns it and the employer pays the premiums, the employee would normally designate some of the benefits to the employer with a collateral assignment agreement. The premium payments are taxed as if the company is giving the employee an interest-free loan, called a loan regime.

If the employer owns the policy and the employee and their family are to receive some of the benefits, that is designated by an endorsement agreement. Those benefits are taxed as an economic benefit, meaning it’s considered a form of pay and calculated annually.

Specify how and when a split-dollar agreement will end

Finally, the written agreement should indicate when the split-dollar arrangement ends and what happens to the policy as a result. Termination may occur upon the employee’s death, retirement, or separation from the employer. It may also come to an end after a specific amount of time or after a predetermined event (such as the dissolution of the company). When the agreement ends, the life insurance policy may be surrendered, settled, bought out, or transferred to another owner. It’s important to note that these events may have tax consequences so be sure to consult a tax expert before determining a course of action.

When should a business owner or individual consider a split-dollar plan?

For many people, an individual life insurance policy may be sufficient to meet their coverage needs. Split-dollar arrangements are generally designed for more specialized business or estate planning needs.

Business owners want to protect the company if a high-value employee passes away

Historically, split-dollar policies were used to cover the potential losses a company could incur if its CEO or other key executive passed unexpectedly. They are still often used that way today, especially at publicly traded companies. Small-business partners and family run businesses may want one in place as well to allow time to find a replacement for high-value roles.

Business owners want to attract and retain high-value employees 

Benefits packages for top employees are very competitive and can include a lot of incentives, like company-paid split-dollar life insurance. While it is less common now, because of the tax changes, it can still help a company compete for top talent.

For anyone who wants to minimize estate taxes

If you apply a split-dollar agreement to a personal policy, it’s often called private split-dollar life insurance. Many people use split-dollar life insurance for estate planning since the death benefit is generally free from federal income taxes when paid to your heirs. Those with substantial estates often use an ILIT to keep the death benefit out of the taxable estate. If you’re concerned about your transfer of wealth, our agents can help you with estate planning.

Life insurance is an important financial tool. Whether it’s an individual policy, an employer-provided group life policy. or even a split-dollar agreement, the right mix can protect your family’s financial future and safety. Our experienced agents can help you customize a suite of products that provide the coverage you need for your unique situation.

Related: Connect with an agent

Neither New York Life Insurance Company nor its agents provide tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.

Frequently asked questions about split-dollar life insurance