What is split dollar life insurance?
When and why it is used?
How is it done?
And what tax issues arise? 

It is neither a type of insurance contract nor a reason for purchasing life insurance.  Instead, it is a method of sharing the attributes and costs of an insurance policy by having various parties share the costs and benefits associated with that policy. 

The Basics – What is split dollar life insurance?

Exempt Life Insurance is comprised of an insurance protection component and a tax-deferred investment component. The split dollar concept recognizes that these components can have separate benefits matched to the parties that require a particular benefit with each party entitled to an interest in the contract. The advantages of sharing the costs and benefits of one life insurance contract over each party owning individual policies are that the parties only purchase the aspect of the policy they want or need, which can result in cost savings and increased rates of return.

A Split Dollar arrangement is established when 2 or more parties enter into a written agreement that stipulates as to how these parties will share the costs and benefits of an insurance contract. One life insurance policy is purchased jointly, and two or more parties enter a separate agreement under which they set out their respective rights, obligations, and entitlements in relation to the life insurance policy. 

The Insurance Company is not party to this separate agreement. 

The insurance contract and the projection of values can form the basis for delineating each parties’ respective interests in the contract. However, these are just projections of hypothetical future values. Care must be taken to ensure that the agreement reflects the spirit of the insurance contract and it’s values and not specifics based upon this hypothetical projection. Stipulations as to premium payments; entitlement to cash values and death benefits; execution of beneficiary designations and the agreed upon approach to the exercise of policy ownership rights should form the basis for this agreement. The insurer does not administer the terms of the split dollar agreement.  The insurer manages the policy as one contract and takes instructions from the joint owners of the policy to carry out transactions relating to the policy.

Why enter into a Split Dollar Arrangement?

A Split Dollar Arrangement involves all parties having complimentary interests in this Insurance Contract. Each party that enters into a split arrangement does so having an insurable need and recognizing that the tax deferred and/or tax-sheltered benefits of an insurance contract is compelling. This shared benefit can make the Split Dollar arrangement cost effective and tax beneficial. Each party to the contract achieves some individual financial goal at a cost that is less than the total of the contract. With very rare exceptions, a split dollar is most effective for those in a high tax bracket with surplus income and some flexibility in how this income is used. On the flip side the party that has an interest in the life insurance proceeds typically have a long-term need for insurance protection and the level cost of a permanent contract is a cost-effective means of mitigating the total life-time insurance cost.

The advantage of split dollar arrangements is the flexibility to structure the split dollar agreement in different ways to meet the objectives of both parties.  The disadvantage is the complexity in determining the cost and benefits for each party in relation to the respective split.

Uses of a Split Dollar Arrangement

A Split Dollar Arrangement is one that generally involves key employees or executives (who may be owner-manager shareholders) and a private corporation.

Key Person Insurance and Personal Savings, Key Person Insurance and a Retirement Compensation Arrangement, Opco Buy Sell Funding and a Holdco Creditor protected Savings, are 3 scenarios which can offer compelling benefits that protect or enhance all parties well being. In all 3 instances the “corporation” is protected by the death benefit and the insured’s financial well-being is enhanced by the tax-sheltered nature of an insurance contract. 

How is a Split Dollar Arrangement Established

Since the separate parties have a shared interest, the agreement must be comprehensive in how it is structured. Corporate level agreements that follow accepted procedures for enjoining a corporation in a financial transaction involving multiple parties, must be followed. Board Resolutions; carefully drafted documentation stipulating to shared interests and obligations; properly worded beneficiary designations that clearly instruct an insurance company on how to distribute the proceeds upon death, ownership structure be it Joint-Ownership, or, Single Ownership with Irrevocable Beneficiary Designations, must form part of a well thought out Split Dollar Agreement. The ultimate goal of these agreements is to provide clarity of purpose and establish each parties’ rights and obligations.

Tax Considerations:

While Split Dollar arrangements are not specifically referenced in the Income Tax Act or Regulations, CRA has acknowledged that individuals may hold an interest in a policy that is separate from another party’s interest in that policy. The acknowledgement of this shared interest forms the basis for why a Split Dollar Arrangement is possible. 

This issue is always; Do the facts of the arrangement confer a benefit commensurate with the cash considerations paid into the contract? Do all parties share the benefit proportionately to the money paid or is one party unduly enriched or impoverished by this arrangement? The main tax issues relate to whether or not a benefit or advantage has been conferred in the context of a split dollar arrangement. The portion of the premium paid by each party must represent fair market value consideration for what that party has an entitlement to.

In essence if the employee or shareholder is paying a reasonable cost for the benefits that he or she is entitled to, a taxable benefit should not arise.

Split Dollar Arrangements can offer some significant advantages and benefits to executives that seek a conservative yet effective appreciation of money, in an insurance contract that offers enhanced personal protections against death, mitigation of onerous taxation on deferred compensation, and immediate funding for their corporation’s well-being in the event of their death. 

Cautionary Note: The foregoing should not be in any way construed as a comprehensive and complete discussion of split dollar arrangements, nor as advice specific to the readers needs. In any financial transaction involving a corporation and shared rights and obligations; legal, accounting and the advice of a qualified insurance professional must be sought. 

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