Life insurance can be an important part of a financial portfolio. Unfortunately, life insurance can be quite expensive, especially if the person being insured is older. Split-dollar life insurance can help reduce the cost of life insurance, making it much more affordable while providing the same benefits.
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Definition of Split-Dollar Life Insurance
Split-dollar life insurance is actually a method of purchasing life insurance, not a specific insurance product. It is a way of funding an insurance product that makes it much less expensive than would be possible in a traditional payment arrangement.
How It Works
Split-dollar transactions basically mean that the owner of the policy and a non-owner third party split or share the cost and the benefits of a life insurance policy. The cost of the premiums are shared by the owner and non-owner making the policy more affordable. Upon the death of the owner, the non-owner of the policy is paid back the share of the premium they paid and the rest of the policy is paid out to the beneficiary of the policy holder.
Split-dollar life insurance is often used by companies to provide their older employees with life insurance at a reasonable rate. In this particular scenario the employer would either pay the entire premium or a share and would then be paid back in full by the death benefit. The rest of the insurance benefit would go to the policyholders beneficiary. As an example, if a company took out a $100,000 policy on an employee and paid out a total of $25,000 in premiums, when the employee died, the policy would pay $25,000 back to the company and $75,000 would go to the employee's beneficiary.
Funding a Buy-Sell Agreement
Another common use for split-dollar life insurance is to fund a buy-sell agreement when a business owner is selling to a much younger person. It is often used in family businesses to sell the business from one generation to another.
In this type of arrangement, the heir (son or daughter) of the business owner would take out a life insurance policy on the business owner. They would be policy owner and and in many cases the beneficiary of the policy. They would also be responsible for paying the policy premiums. If the policy premiums turn out to be too expensive for the heir to pay, then a split-dollar arrangement would be an excellent option to lower the cost of the premium.
Tax Implications of Split-Dollar Life Insurance
There are tax implications to split-dollar life insurance. The premiums are not deductible by either the business or the employee they are covering. The portion of the premium paid by the employer is considered an economic benefit to the employee and is considered a form of compensation, which has tax implications. It is best to check with a tax attorney or accountant as to the best way to handle a split-dollar insurance transaction.