Corporate endorsement split dollar plans help safeguard businesses from potential financial setbacks that may arise due to the death of an executive or key employee, as well as provide a benefit for the employee in question.

Throughout the employee's tenure at the organization, the company assumes responsibility for premium payments and maintains ownership of the insurance policy, while allocating a portion of the death benefit to the employee. Once the employee's service agreement reaches its conclusion, ownership of the  life insurance policy may be transferred to the employee, who becomes entitled to the entire death benefit.

How corporate endorsement split dollar works

In a corporate split dollar plan, sometimes called an economic benefit regime, a business provides the benefits of a life insurance policy to a key employee by splitting the value of the policy between the employee and the company.

Under this arrangement, the business owns the policy, pays the premium, and retains all rights to the cash values for the length of the employee’s agreed-upon tenure. The business endorses a portion of the policy’s death benefit to the employee to ensure that his or her beneficiaries receive financial support in the event of his or her death. However, the business retains control over the policy and its cash values. The key employee pays taxes on the value of the life insurance protection, called the reportable economic benefit charge (REBC), each year.

Tax and financial benefits

In a corporate split dollar arrangement, the cash value of the policy is reflected as an asset on the business’ balance sheet. The business can use or borrow against the cash value of the policy.

Generally, the premiums paid on a life insurance policy may not be deducted as a business expense; however, once the business transfers the policy to the key employee, the business may deduct the fair market value of the policy.

As with most life insurance, the death benefit of the plan is received tax-free by the beneficiaries.

Client applications

Corporate split dollar plans can be an attractive benefit strategy for many business owners and key employees:

• Key employee retention: Businesses may use endorsement split dollar plans to encourage key employees to stay with the company for a set term of service, in addition to enhancing their compensation package by providing valuable life insurance coverage to the employee.
• Business continuity for key executives: An endorsement split dollar arrangement helps to secure the company's financial stability in case of the executive's death, as the company will receive a portion of the death benefit to cover any potential losses or expenses related to the loss of the key executive.

Product selection

Universal life (UL) insurance policies are most commonly used for endorsement split dollar plans because they offer a death benefit and a cash value component.

In a universal life policy (including current assumption and indexed UL) the cash value grows based on underlying product performance. Universal life provides for flexibility by allowing the policyholder to adjust the death benefit and premium payments.

Endorsement split dollar plans may also be structured with whole life policies, which typically have greater no-lapse guarantees and cash value growth, but which are less flexible and often more expensive than universal life.

Case study: Endorsement split dollar in action

Amy is a 42-year-old executive at a mid-sized engineering firm who is essential to its daily operations and overall success. Well aware of Amy’s talent, the business’ owner implements an endorsement split dollar arrangement to encourage her to remain with the company.

The business applies for and owns a life insurance policy on Amy, with $1 million of permanent coverage. The business intends to pay the annual premium of $49,538 for 20 years, until she retires at 62.

The death benefit of the policy is split between the business and Amy, with $500,000 being endorsed to Amy and the residual amount being retained by the business for keyperson purposes.  In the first year, Amy's reportable economic benefit is $245, which results in a $74 tax payment at her 30% income tax bracket. Over time, the economic benefit charge increases and in year 20, it rises to $970 with a tax payment of $291.

The business and Amy enter into a secondary agreement, in which the business will transfer ownership of the policy to Amy at the end of the 20th year, as a retention tool. At that time, Amy will pay income tax based on the policy's fair market value, which can be withdrawn from the policy, and the business will receive a corresponding tax deduction. If Amy leaves before the end of the 20th year, she will not receive the policy and the business can retain it for its own use.

Additional considerations

How split dollar factors into employee compensation

In addition to providing an incentive to reduce turnover, endorsement split dollar plans can sometimes be a cost-effective way for businesses to reward key employees. Because the employer retains the policy, he or she can recover premium payments in the event that the insured individual passes away or leaves the business prior to the agreed-upon date. 

Upon completion of the contract period, employees have access to deferred income through the life insurance policy's cash value to supplement their retirement savings, in addition to the tax-free death benefit for their beneficiaries.

In order to implement a split dollar plan, the employee must be insurable. While the arrangement may make it easier for some employees to obtain coverage due to the company’s stronger financial position, the premium costs for a split dollar plan for an employee with health issues may be higher.

Transferring or terminating an endorsement split dollar plan

An endorsement split dollar generally terminates in one of three ways:

1. Premature departure: If the employee leaves the company prematurely, the policy may be surrendered, and any cash value will revert to the company. 
2. Death of the employee: If the insured employee passes away, the employer will receive an amount equal to at least the greater of premiums paid or cash value - or a specified portion of the death benefit. The remaining proceeds are paid to the employee's designated beneficiaries. 
3. Vesting of policy ownership: If the employee reaches the end of an agreed upon service period, the policy can be transferred and he or she may become the sole owner of the life insurance policy and entitled to the entire death benefit.

Administration and compliance governing plan transfers

The administration costs for a split-dollar plan vary, but are generally lower than other forms of employee benefit plans. 

Tax and regulatory requirements can be managed by a third-party administrator or financial advisor. In fact, many insurance carriers offer administrative support as part of their services, including premium payment services and compliance monitoring, which can help reduce the burden on the business.

Reportable economic benefit charges

During their tenure with the company, the employee may also must also recognize and pay tax on the REBC each year to keep the death benefit tax-free. The REBC reflects the value of the life insurance protection to the key employee (once the business retains their portion), and is taxed as ordinary income to the employee.

Section 101(j) compliance

Businesses that implement a split-dollar life insurance arrangement must comply with Section 101(j) of the Internal Revenue Code (IRC), which applies specifically to corporate-owned life insurance policies. The Code sets specific recordkeeping and reporting requirements and sets limits on the amount of premiums that can be paid by the business. 

Section 409A compliance

If structured improperly, split-dollar arrangements may fall under Section 409A of the IRC, which governs the treatment of non-qualified deferred compensation plans. 

Under Section 409A, there are specific requirements for the timing and method of deferral of compensation, the payment of deferred compensation, and the timing and method of any acceleration of payment. If a policy is transferred within two and a half months of the end of the calendar year in which the employee’s service requirement is met, the policy is not subject to 409A regulations.

Related strategies

Other split dollar solutions are designed for individuals or estate planning needs:

• Private split dollar arrangements allow individuals, such as family members or business partners, to share the costs, benefits, and ownership of a life insurance policy.
• Reverse split dollar arrangements allow an insured employee to pay the premium costs and allocate a portion of the death benefit to another entity, often a trust or family member.