Andrew Bainbridge- Client Service Specialist
Employer owned split-dollar life insurance is a method of sharing both the obligations and benefits of life insurance with an employee while also providing an incentive for retention of key-employees. For the purposes of this article, assume the employer is the owner of the policy and is providing an interest in the policy to the employee.
Split-Dollar agreements typically have the employer responsible for funding the policy, while the employee is provided a portion of the death benefit proceeds. This benefit is an incentive for the employee as these proceeds permit the employer to provide a death benefit to the employee which is often much less than the real economic cost would prove to be.
Below is a summary of other benefits of an employer provided Split-Dollar Plan:
- Employer provides life insurance protection to the employee and gives the employee the right to designate a portion of the death proceeds to the beneficiary
- Employer owns the policy, retains the policy cash values and determines who is eligible
- Employer does not require IRS approval; however, there are other reporting requirements
- Employee chooses the beneficiary who receives death benefit protection for a term cost that is income tax free
Under a traditional permanent life insurance policy, the amount at risk is defined as the monetary difference between the current death benefit and the accrued cash value. Under a split-dollar agreement, the definition of net amount at risk extends to the obligations of the employer plus the cumulative premiums paid.
For example: if you have an employer owned permanent life contract with $75,000 in cost basis (cumulative premiums paid) resulting in a current $500,000 death benefit and a split-dollar agreement in place on the contract granting $250,000 to the employee, your net amount at risk is $175,000.
It is therefore important to consider how the cumulative premiums paid over time can impact your net amount at risk negatively. Extending the previous example, if you are paying $5,000 in premiums each year, there will be a point in time where the net amount at risk could grow to a point as to compromise the ability of the corporation to recoup their original investment into the policy.
One way clients deal with this potential landmine is to specify in their split-dollar agreement that the employee be owed a certain percentage of the net amount at risk. An example of that language could be: “a death benefit will be payable to the executive’s designated beneficiary equal to seventy-five percent (75%) of the portion of the insurance proceeds on the life of the Executive designated as Net Amount at Risk (NAR).”
Consistent and thorough review of your current split dollar agreement is an effective way to mitigate this risk. Please contact Executive Benefits Network for more information on how reviewing a split-dollar agreement could help your corporation attract and retain key talent.