Split-dollar life insurance

Split-dollar life insurance is not a type of policy. It is an agreement between two parties, usually an employer and an employee or a parent and a trust, to share the cost and benefits of one permanent life insurance policy. One side generally pays most or all of the premiums and gets repaid from the policy, and the other side gets the rest of the death benefit. Since 2003 the Treasury regulations have taxed these arrangements under one of two mutually exclusive regimes, so the written terms drive the tax result.

The basic idea

In a typical employer arrangement, the company advances the premium on a permanent policy on an executive. At the executive's death, the company is repaid its premiums (or the policy's cash value) and the executive's family receives the balance of the death benefit. The executive gets large coverage at a low out-of-pocket cost; the company gets its money back and a retention tool.

The same structure is used in family planning, where a parent or a family entity advances premiums on a policy owned by an irrevocable life insurance trust, an irrevocable trust, so the policy stays out of the insured's estate while the parent is repaid. See irrevocable life insurance trusts.

The glossary entry split-dollar arrangement gives the short definition. Under Treas. Reg. section 1.61-22(b), an arrangement is split-dollar if it is between an owner and a non-owner of a life insurance contract, either party pays all or part of the premiums, and at least one party is entitled to recover those premiums from the contract proceeds, and it is not part of a group-term plan.

Two regimes: economic benefit and loan

The regulations (final in 2003) apply to arrangements entered into after September 17, 2003, and to older arrangements that are materially modified afterward (Treas. Reg. 1.61-22). Every arrangement falls into one of two buckets.

Economic benefit. The non-owner is taxed each year on the cost of current life insurance protection (the death benefit the non-owner can receive, times an IRS rate), plus any cash value the non-owner can reach, plus other benefits. The IRS rate is based on its published table or, in some cases, the insurer's own term rates. Employers often treat this cost as imputed income; see imputed income.

Loan. If premium payments are treated as loans, interest must be charged at least at the applicable federal rate, or the below-market loan rules treat the difference as income or a gift. The loan is typically repaid from policy proceeds or cash value.

The rules also cover "equity" split-dollar designs, in which the non-owner has an interest in cash value above the owner's repayment right. These designs get more tax attention and need careful drafting.

Where split-dollar is used today

• Executive retention. The employer funds a policy for a key executive and is repaid at death or retirement, often with the executive vesting in the policy over time. It differs from a section 162 executive bonus plans, where the executive owns the policy outright and pays tax on the bonus.
• Estate planning. A grantor funds an ILIT's policy through split-dollar so the trust need not use annual gift exclusions. The 2026 annual gift exclusion is $19,000 according to the IRS. Split-dollar can let wealthy families fund larger premiums, but the estate tax inclusion of the repayment right and the loan terms require careful structuring.
• Business owners. A company funds coverage on shareholder-employees, though this overlaps with buy-sell and key person uses; see funding a buy-sell agreement with life insurance.

Rules that apply on top

• Employer-owned life insurance. When the employer owns the policy on an employee, IRC section 101(j) can limit the tax-free death benefit unless notice and consent were given before issue and an exception applies. Form 8925 reports these contracts. See section 101(j) notice and consent.
• Public companies. Employer loans to directors and executive officers of public companies are restricted by the Sarbanes-Oxley Act, and many public companies stopped using loan-based split-dollar for executives for that reason.
• Deferred compensation. Some split-dollar designs promise benefits later, which brings IRC section 409A into play; see life insurance in nonqualified deferred compensation.
• Premium deductions. Under IRC section 264(a)(1), an employer generally cannot deduct premiums when it is a beneficiary of the policy.
• Policy design. Policies must still meet the cash value limits of IRC section 7702, and overfunded policies can become modified endowment contracts.

A hypothetical example

Say a company advances $30,000 a year for 10 years, $300,000 in all, on a policy insuring a 50-year-old executive, under an economic benefit arrangement where the company owns the policy. At the executive's death the company is repaid the $300,000 (or a cash-value formula set in the agreement), and the executive's family receives the rest of the death benefit. Each year the executive reports the cost of the death benefit portion the family can receive as taxable income. The numbers are invented; real costs depend on the policy and the IRS rate table in force.

Risks and trade-offs

Potential advantages: the executive gets coverage cheaply; the company's cash is repaid; planning flexibility for families with large estates.

Potential disadvantages:

• Complex documents, and the IRS looks at substance, not labels.
• Annual taxable income to the executive or interest charges to the borrower.
• If the policy underperforms, there may not be enough cash value to repay the funder.
• If the executive leaves, the arrangement needs a defined exit: terminate, roll out, or transfer the policy, which can trigger taxation.
• Employer accounting and securities-law complications.

It is not appropriate for someone who wants simple, low-cost coverage. Term insurance or a bonus plan is easier; see the types of life insurance, explained.

The mechanics, tax reporting and interaction with estate and securities rules mean a tax attorney should draft split-dollar agreements rather than relying on an insurer's sample form.

Key takeaways

• Split-dollar is an agreement to share one policy's premiums and benefits, not a policy type.
• For arrangements entered after September 17, 2003, Treas. Reg. section 1.61-22 (economic benefit) and section 1.7872-15 (loan) decide the tax result.
• Employer-owned policies also face IRC section 101(j) notice-and-consent and Form 8925 reporting.
• Common uses are executive retention and funding trust-owned policies in estate planning.
• Exit terms, policy performance and tax reporting are the usual trouble spots.