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Understanding
Reverse Split Dollar Life Insurance
To understand
reverse split-dollar you should start with regular
split-dollar. Split-dollar life insurance is an ideal fringe benefit
plan because it brings together the life insurance needs of one person
with the premium-paying ability of another. Split-dollar insurance
refers not to a type of policy, but to a method of paying for the
policy. There are three elements of a permanent life insurance policy
which can be spli9t:
the ownership,
the beneficiary, and
the premium.
Why Reverse
Split-Dollar?
Reverse split-dollar takes
its name as the reverse of a conventional split-dollar plan. In
regular split-dollar, the employee is entitled to a substantial
portion of the death benefit proceeds, and the employer retains an
interest in the cash value of the life insurance policy.
Reverse split-dollar reverses
the benefits found in regular split-dollar. The reverse split-dollar
strategy is to apply the tax principles for regular split-dollar in
reverse to achieve favorable, but different business and tax results.
In a reverse split-dollar
plan, the employee owns the cash value portion of the policy, and the
employer owns the policy's death benefit.
The Appeal of
Reverse Split-Dollar
Reverse split-dollar
insurance offers a unique option in fringe benefit planning. Whether
your main goal is to help your key employee purchase much-needed life
insurance, to acquire key person insurance coverage for your business,
or even to provide yourself with a stream of money for your own
retirement, reverse split-dollar can work for you and your business.
Business
Applications
In considering reverse
split-dollar, it's a good idea to focus on two different business
applications.
1
Reverse split-dollar can be an effective employee benefit plan that
combines key person insurance coverage for your business with a life
insurance benefit for your key employee.
2
Reverse split-dollar can be an excellent idea for you, the business
owner. With reverse split-dollar, you can use corporate dollars to
provide yourself with a cash value life insurance policy that you
would control during your retirement years.
Understanding
Economic Benefit
The value of the insurance
protection that you receive under the policy during the reverse
split-dollar agreement is referred to as the economic benefit. It is
the economic benefit that determines an employer's premium payment
each year under the plan.
The economic benefit concept
is based on a P.S. 58 rate, which in turn is based on the age and
gender of the insured. The older the insured, the higher the P.S. 58
rate. Using the appropriate rate, the economic benefit is also based
on the amount of the life insurance coverage.
A reverse split-dollar plan
typically has the employer pay, as its share of the premium, an amount
measured by the P.S. 58 value of the death benefit that is assigned to
the employer.
Plan Designs
The premium payment design is
frequently the heart of reverse split-dollar strategy. Two premium
structure approaches are commonly used in reverse split-dollar plans:
an increasing premium approach and a level premium approach. Both
plan designs are described here.
Increasing
Premium
In this approach to reverse
split-dollar funding, the employer pays an increasing premium. Since
the P.S. 58 rates increase as the insured ages, the employer makes an
increasing premium contribution over the course of the reverse
split-dollar arrangement. The employee pays the remaining portion of
the premium. The employee owns the cash value and is entitled to any
death benefit that exceeds the employer's share.
Level Premium
The reverse
split dollar life insurance concept is simply a method of purchasing a
life insurance policy to provide a death benefit. It is a unique
approach which enables two different parties to join together in the
purchase of life insurance for their mutual benefit.
Usually, split dollar arrangements are between an employer and a
select employee. The employee can be an owner or a non-owner.
Reverse split dollar is used to fulfill many needs of both the
employer and the employee. Some uses include:
Any time the employer needs the death benefit and the
employee wants to accumulate cash.
Loan
indemnity.
Key
person indemnification.
Funding death benefit only nonqualified
deferred compensation plans.
Supplemental retirement benefits.
Funding
buy-sell agreements.
Stock
redemption.
The employee owns the policy and assigns all or a portion
of the death benefit to the employer for a set time period.
The employee retains complete control of policy cash
values.
The employer pays a premium up to the PS58 costs with the
employee paying the balance, if any.
At the end of the stated time period, full control of the
death benefit is returned to the employee.
Bonus may be paid to the employee to cover the premium in
excess of the PS58 costs.
The Reverse Split Dollar Agreement between the employer and
the employee is structured to terminate at a specific point in time or
upon the occurrence of a certain event such as retirement.
The
Employer's Perspective...
Why Enter Into a Reverse Split Dollar Agreement?
I The plan can provide death benefit
protection for the loss of a key employee, to secure a loan or to fund
benefits for survivors
II The employer can be selective in favor of
an employee.
Employer sponsored reverse split-dollar plans are not subject to
government reporting requirements (e.g. ERISA)
The
employer, through life insurance policy cash values, can transfer
"locked up cash" from the corporation to the owner or key employee.
Split-dollar arrangements may vary
depending on the needs of the parties
and the actual agreement
The
Employee's Perspective
Why Enter Into a
Reverse Split-Dollar Agreement?
Employee receives supplemental cash accumulation in the
form of
policy cash values with minimal outlay of personal fluids.
Policy cash values
accumulate tax deferred.
IRC
§1O1(a)(1))
Policy loans and cash
values can provide funding
for retirement,
college, home, etc.
Employee controls the
right to designate a beneficiary for the portion
of the death benefit over and above the Employer's
share.
Reverse split-dollar
can be particularly effective where the employer is
in a
lower tax bracket than the
employee.
|
Premiums
$5,000
Tax
Rate: 0%-15% |
The
earnings needed to pay premiums (e.g. $5,000) are taxed at a low
rate (0%-15%) whereas the personal income required to pay the
income tax on the economic benefit (e.g. $350) is taxed at a
higher rate (up to 40%). |
Economic Benefit
$350
Tax Rate: Up to
40% |
The Employee...
Purchases and owns the policy.
Has the right to name
the beneficiary for an agreed upon share of the death benefit.
Owns
his/her entire policy cash value.
The
Employer...
Receives its agreed upon share of the policy death benefits.
Pays up to the
government PSSS term rates or company's alternative rate as an
economic benefit, for the designated death benefit.
Releases all
interests in the policy when the agreement terminates, generally at
retirement.
Split-dollar life insurance is an ideal
fringe benefit plan because it brings together the life insurance
needs of one person with the premium-paying ability of another.
Split-dollar insurance refers not to a type of policy, but to a method
of paying for the policy. There are three elements for a permanent
life insurance policy which can be split:
[] the ownership;
[] the beneficiary; and
[] the premium.
To understand reverse split-dollar, you should start with regular
split-dollar.
Split-Dollar
Reverse split-dollar takes its name as the reverse of a conventional
split-dollar plan. In regular split-dollar, the employee is entitled
to a substantial portion of the death benefit proceeds, and the
employer retains an interest in the cash value of the
life insurance policy. Reverse split-dollar reverses the benefits found
in regular split-dollar. The reverse split-dollar strategy is to apply
the tax principles
for regular
split-dollar in reverse to achieve favorable, but different business
and tax results. In a split-dollar plan, the employee owns the
cash value portion of the policy; and the employer owns
the policy's
death benefit. Reverse split-dollar insurance offers a unique option
in fringe benefit planning. Whether your main goal is to help your key
employee purchase much needed life insurance, to acquire
key person insurance coverage for your business, or even to provide
yourself with a stream of money for your own retirement, reverse
split-dollar can work for you and your business. Use reverse
split-dollar when your corporation needs death benefit protection and
you want to provide cash benefits inside a life insurance policy for
yourself and/or a key executive.
In considering
reverse split-dollar, it's a good idea to focus on two different
business applications. Reverse split-dollar can be
an effective employee benefit plan that combines key person insurance
coverage
for your business with a life insurance benefit
for your key employee. Reverse split-dollar can be an
excellent
idea for you, the
business
owner. With reverse
split-dollar, you can use corporate dollars to provide yourself with a
cash value life insurance policy that you would control during your
retirement years.
Employee:
Key Person Coverage/Employee
Benefit Combination
Protects your business in the event of the loss of a key employee.
Ties a valued
key employee to your business by providing a cash value life insurance
policy for his or her benefit at retirement.
Business
Owner:
A Source of Retirement Money
Uses
corporate dollars to meet your personal life insurance needs.
Shifts corporate dollars to you on a
tax-favored basis.*
Avoids
or reduces a potential retained earnings problem in your corporation
*
under current tax law
Understanding
Economic Benefit
The value of the
insurance protection that you receive under the policy during the
reverse split-dollar agreement is referred to as the economic
benefit. It is the economic benefit that determines an employer's
premium payment each year under the plan.
The economic benefit concept is based on a P.S. 58 rate, which in
turn is based on the age and gender of the insured. The older the
insured, the higher the P.S. 58 rate. Using the appropriate rate, the
economic benefit is also based on the amount of the life insurance
coverage. A reverse split-dollar plan typically has the employer pay,
as its share of the premium, an amount measured by the P.S. 58 value
of the death benefit that is assigned to the employer.
The premium payment design is frequently the heart of reverse
split-dollar strategy. Two premium structure approaches are commonly
used in reverse split-dollar plans: an increasing premium approach and
a level premium approach. Both plan designs are described here.
From the outset, a reverse split-dollar agreement is designed to last
only a set number of years. Typically, the plan will end at the first
of two events:
At
the insured's retirement.
At
the insured's death.
Most reverse split-dollar agreements are designed to last until the
employee's retirement, for instance, at age 65. At that point, the
employer's interest in the policy is over. The employer paid for, and
received, life insurance coverage for the duration of the agreed-upon
term.
At age 65, the employee then owns the entire life insurance policy and
all of its values. On the other hand, if the employee dies during the
term
of the reverse split-dollar agreement, then the employee's
beneficiary would be entitled to the policy's cash value (at the time
of the insured's death), and the business collects the rest of the
life insurance proceeds as key person coverage.
Business pays portion of
premium equal to the economic benefit
Employee pays balance
& owns policy cash value
At Death Before
Retirement
At Retirement
Income tax-free proceeds
are paid
Business receives
balance of proceeds
Family receives
proceeds equal to the cash value
Family named as beneficiary and cash
value available for
retirement income
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