"Life Insurance: Dispelling Illusions"
by Joseph E. Godfrey III

"Split Hairs: Split-Dollar Life Insurance"
by Carrie Coolidge

"Inheriting a Business Just Got Harder"
by Mike McNamee

"Is Your Policy Getting Zapped: Swapping Insurance Coverage?"
by Lewis Braham

"Life Insurance For Sale in a Secondary Market"
by Jeff D. Opdyke

"New IRS Ruling May Boost Use of Estate Planning Tool"
by Tom Herman

"A Hybrid Haven"
Rob Report Worth

"Court Ruling Bolsters Estate-Planning Tool"
Wall Street Journal

"IRS Grants a Wish"
Forbes Magazine

ARTICLES HOMEPAGE

© 2003
FORBES MAGAZINE

Split-dollar life insurance was one of the best executive perks going, until the tax rules changed.

It was one of the sweetest executive perquisites under heaven. In a goody known as split-dollar life insurance, an employer typically ponied up 90% of the premium and the executive a mere 10%. But the executive didn't exactly split the benefit with the company. When he or she died, the company would get back just the premiums it put in, while the spouse would get--free of estate tax and free of income tax--everything beyond that. Alternatively, the executive could turn the policy into retirement income, extracting excess cash value as a tax-free "loan."

This was nothing like the $50,000 group term life that ordinary workers get tax-free. Such companies as Cendant and Polo Ralph Lauren were paying millions in annual premiums on behalf of their chief executives. This rankled at the Internal Revenue Service. The agency came to view the perk as just another form of compensation that should be taxed.
Well, when trouble came to Enron, which had lush split-dollar plans for Jeffrey Skilling and Kenneth Lay, Congress and the IRS pounced upon the perk like avenging angels. What's left is a whole lot less sweet. You get to keep the buildup tax-free under certain circumstances, but you can't have your company keep piling in more cash without paying them interest on it.

Starting Sept. 18, new split-dollar arrangements require the employee to pay interest (around 4.5% annually) to the employer for the premiums it is advancing on his or her behalf. See, the IRS now considers company-paid premiums to be loans to the executive.

Older policies are grandfathered, but there are gotchas. If you make major changes to an existing split-dollar plan purchased before Jan. 28, 2002, you will owe your company interest on the accumulated premiums it paid. What kind of changes? A big one might be altering the type of policy, such as from whole life to variable, a type of policy that gives you more control over investment choices. Others might be increasing your coverage or switching insurers.

Some changes are allowable, thankfully. One is in your beneficiary, useful if you get divorced. Other changes the IRS will let you get away with: a new address, a change of the interest rate payable on a policy loan and the policy's transfer to a new carrier after your original insurer collapses. Whatever, don't make any changes without advice from an insurance pro up to speed on the new law, says Lee J. Slavutin, an insurance expert with New York-based Stern Slavutin-2.

There's a wrinkle that concerns the top brass. If you are one of the highest-ranking five executives at a publicly traded company, your employer can't keep paying your premiums--period. That's because the Sarbanes-Oxley financial reform law has banned loans to the corporate hierarchy, and by now companies should have stopped paying premiums on behalf of top executives.

What about executives not in the top five? Act quickly--before Dec. 31. Terminate the premium-splitting agreement but keep the policy in force with you as sole owner, says Joseph E. Godfrey III, director of CPA/client services at American Business & Professional Program in New York. You will have to repay your employer all its premiums immediately, but you can keep the full policy in force and continue to enjoy tax-free build-up--and access to the cash value, via policy loans. You could, for example, use a policy loan to pay back the employer.

Neglect to terminate the premium-splitting arrangement by Dec. 31 and you will be badly hemmed in. All of the cumulative contributions from the employer could become a loan on which you will owe interest. Try to get out of this mess by canceling the policy and you wind up with a tax bill on all the policy's appreciation, says Thomas Ledbetter of Garrett, Prather, an insurance brokerage in Wayne, Pa.

Split-dollar arrangements have been among the most common of executive benefits since the 1960s, when General Electric set up the first one. There are an estimated 800,000 split-dollar contracts now in force. What a shame that Enron had to spoil this party.