What are the types of split-dollar life insurance?

A split-dollar life insurance plan is a special contractual agreement between an employer and an employee, providing that both parties will share the costs and benefits of a permanent life insurance policy.

There are three types of split-dollar life insurance plans:

• classic split-dollar,
• equity split-dollar and
• reverse split-dollar.

Classic Split-Dollar Life Insurance

Classic split-dollar arrangements involve the splitting of a policy between a company and an employee.

Under a classic split-dollar plan, a corporation pays the amount of premium equal to the increase in the cash value, while the employee pays the rest of the premium. Upon the death of the employee or the termination of the plan, the accumulated cash-surrender value is due to be paid to the company.

Since employees pay the principal amount of the premiums, the beneficiaries that they have designated will receive the death benefits. This classic arrangement, however, is not very common, since employers nowadays tend to pay the larger share of the annual premium.

Equity Split-Dollar Life Insurance Plans

Equity split-dollar is a variation of classic split-dollar life insurance plans, which has sparked controversy in the tax treatment of split-dollar life insurance because of the way the employee's part of the cash value is treated.

Essentially, in an equity arrangement the employee's annual contribution is equal to the amount of the pure term insurance coverage, while the remainder of the premium is paid by the employer. If a policy is terminated or the insured dies prematurely, the employer will be paid the amount of the policy's cash value or the total sum of the premiums paid, whichever is less. If the interest the employee accumulates in the cash value exceeds the employer's share of the premiums, the surplus belongs to the employee.

Reverse Split-Dollar Life Insurance

This is a plan that offers benefits to the employee on a reversed-role basis.

Reverse split-dollar requires that the employer's contributions amount to the term insurance portion of the policy, whereas the employee pays the balance of the premium. In the event of the employee's death, the beneficiaries receive the cash-surrender value.

If the reverse split-dollar plan terminates while the employee is still alive, the employee can receive the cash value, or decide to keep the policy in force by paying the entire future premiums themselves. In that case, the employer receives nothing.

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