A split dollar plan is NOT about a specific life insurance product but rather is a contractual strategy for using life insurance.
What is Split Dollar Life Insurance?
Split dollar life insurance DEFINITION: a plan that allocates the costs and benefits of a life insurance policy in a specific manner by contract in order to maximize tax advantages for the employer AND employee.
Because split dollar plans offer tax advantages, these plans are highly regulated by the IRS and are therefore more “involved” than simpler strategies such as executive bonus plans. This is also the reason that the tax laws governing split dollar plans have undergone changes since the major 2003 regulations and remain under careful watch by lawyers and advanced market insurance practitioners.
Split dollar plans have seen significant growth in the past two years, with a 32% increase in implementation among privately held companies since 2022. As of 2025, 65% of these arrangements are structured as loan regime plans, up from 51% in 2020.
How Split Dollar Life Insurance Plans Work
The term “split dollar” refers to sharing the economic benefits (of a permanent life insurance policy) between different parties. Usually, parties to a split dollar arrangement are a closely held or family business and a key employee.
Split dollar plans can provide planning flexibility for a closely held business in a number of ways including:
- Providing financial incentive to a key employee
- Funding certain buyout arrangements
- Estate and business succession planning for the business owner
To achieve the above benefits, a split dollar plan provides a way of paying for AND owning permanent life insurance by ALLOCATING the cost of premiums AND the benefits of the policy between the employer AND the employee.
Because a large part of our mission at insuranceandestates.com is to empower small business owners, this article is focusing on the benefits and pitfalls that are most relevant to closely held businesses.
Beyond Small Business Applications
You should at least be aware that split dollar plans are also used in other venues such as educational institutions (universities) or healthcare organizations, as a way to provide incentives for key personnel. In fact, large universities such as the University of Michigan, reputedly use these plans for large compensation packages for coaches. Jim Harbaugh’s life insurance policy is estimated to be worth $75 million dollars.
In 2025, we’re seeing substantial growth in split dollar implementations in healthcare organizations, primarily to retain specialized physicians and administrative leadership.
For public companies, the Sarbanes Oxley Act is a huge consideration because there are rules pertaining to making loans to employees. For smaller companies, concerns arise when defining whether benefits are being realized as an owner/shareholder OR as an employee.
How to Structure Split Dollar Life Insurance Arrangements
How a split dollar plan is structured will depend upon the specific goals and concerns of the business owner AS WELL AS the specific situation of the key employee. The overall tax situation AND estate planning goals of each party are usually the primary considerations.
Closely Held Business Considerations
When creating a split dollar plan for a closely held business, the first important question is how to classify an individual who is involved in ownership of the business AND who is benefiting from the policy. A related question is the type of business entity that is concerned such as an c corporation, s corporation or an LLC, as the specific entity will typically have an impact on the tax ramifications. The key question is whether the individual involved in the business is receiving benefits as a business owner (shareholder, partner/LLC member) OR as an employee.
If an individual receives a life insurance benefit as an employee, that benefit will be taxed as regular income. If the benefit is received as a shareholder/partner or LLC member, the benefit may be taxed as a dividend or return of capital. Because taxation rates for regular income are much higher than dividend tax rates, there can be big advantages in documenting the individual as a shareholder in a corporation.
If the corporation is a “C Corporation“, the shareholder benefit will be taxed as a distribution to the same extent that the corporation has earnings; however these are the earnings of the corporation and not necessarily the shareholder individually.
If the corporation is an “S Corporation” the benefit will also be taxed as a distribution; however, because the S corp is a pass-through entity, earnings are reported on the shareholder’s personal tax returns and thus the benefits are realized as after-tax income.
Things get a bit more uncertain for split dollar arrangements involving partnerships and LLCs because the IRS rules are very unclear about how to classify the life insurance benefits. The question seems to be whether it will be deemed a “guaranteed payment to a partner” rather than payment to an employee, which is likely in a partnership or LLC where the individual isn’t acting directly as an employee.
Key Decisions for Designing Split Dollar Plans
A split dollar plan is structured by a contract which will ALLOCATE a number of aspects of the permanent life insurance to either the employer or employee. The aspects to consider when creating a strategy are:
- Who will pay the premiums
- Who will have access to the cash values
- Who will be the beneficiary of the death benefit
- Who will have the authority to make policy decisions (these vary depending upon the type of life insurance used)
Who Will Pay the Premiums?
A closely held business (hereafter “employer”), can pay the entire premium pursuant to a split dollar arrangement.
The employee (employee, shareholder, member, partner is referred to collectively hereafter as “employee”) may either pay nothing for the insurance or may pay a portion of it that relates to that portion of benefits received by the employee.
For example, a common arrangement is for the employee to pay the cost of term insurance relative to the policy and if the policy is permanent life insurance, such as a dividend whole life insurance policy OR indexed universal life, the cost of term may be substantially less than the actual cost paid by the employer.
The total costs are usually estimated for IRS purposes by using the Table 2001 annual renewable term rates or the insurer’s alternative qualifying term rates. As of 2025, economic benefit costs using these Table 2001 rates have increased by approximately 8% since 2022 due to mortality table adjustments.
Under these kinds of arrangements, the employer pays the balance of the premiums.
Another less common approach is for the employer to pay up to the amount of the increase of the cash value in a given year. This kind of arrangement would dictate lesser costs in the early years and higher costs as the policy matures and benefits accrue to both employer and employee.
Generally, the logic for these kinds of arrangements are that the employer retains the benefit of the cash value accrual in the policy and is assigned a portion of the death benefit to cover premium costs.
Who Will Have Access to the Cash Values?
A split dollar plan must address who will have access to the cash value that accrues in a permanent life insurance policy. For example, an employer could be entitled to receive the greater of the premiums actually paid OR the cash surrender value of the policy. Another possibility is for the employer to receive back only the premiums advanced and the employee to receive the cash value in excess of this amount (the equity in the policy).
Who Will Be the Beneficiary of the Death Benefit?
When determining who will have access to the cash value, it is important to identify the various goal of the split dollar plan and these are summarized in the questions of death benefit and control over the policy. For example, is the goal to provide the use of cash value to the employee during his/her lifetime as an incentive (golden handcuffs). Structuring the life insurance on a key person in such a way as to incentivize the key person to remain at the business until fully vested in the life insurance policy is a fantastic way to promote strong employee loyalty.
Alternatively, the goal may be to provide an accruing death benefit to protect the employee’s loved ones and/or the employer, while reserving the right of the employer to use the cash value as a source of business funding. Choosing this route provides an alternative source of liquidity for the business, which may provide a safety net for smaller businesses engaged in a high growth phase where cash is scarce and margins are tight.
Who Will Have the Authority to Make Policy Decisions?
Other contractual issues to be addressed include who will make the policy decisions. A key decision that relates to who has the right to use the cash value is who pays the interest on policy loans. Typically, this will fall onto the party who is responsible for taking out the loan. However, policy loans can be another incentive an employer uses to maintain the loyalty of a key employee, particularly if the split dollar plan requires any policy loan to be repaid if the employee has not been with the company for the requisite amount of time.
Additional decision making questions, which do not apply to cash value life insurance policies, may apply to universal life policies such as how much premium will be paid on the policy, and, if the policy is a variable policy, who authorizes the specific investment decisions on the policy. It is due to the issues that may arise concerning variable universal life policies that we do not consider them optimal for split dollar strategies.
Two Ways to Structure Split Dollar Plans
There are two primary ways that a split dollar plan is structured which are:
- The endorsement approach; and
- The collateral assignment approach
The Endorsement Approach
The endorsement approach allows the employer the benefit of retaining ownership of the life insurance policy.
Under this approach, the employer owns the policy and pays the premiums AND endorses to the employee the portion of the death benefit that is in excess of the greater of the premiums paid or cash value of the policy. This approach is sometimes referred to as an “economic benefit” approach which is discussed in more detail below because the employee is only taxed based on the economic benefit that he/she receives.
The employer’s options for valuing the economic benefit include the “equity approach” and “non-equity approach“. Under the former, the employer is entitled to a return of the premiums paid and if the cash value exceeds the premium, this amount goes to the employee. Under the latter, the employer is entitled to the greater of the cash surrender value OR the premiums paid.
A disadvantage of this approach is that the ownership of the policy may be deemed to a business owner (shareholder, member or partner) and this may cause the policy to be included in his/her estate. Depending upon the estate circumstances, this could result in unwanted estate tax exposure for family business succession planning.
The Collateral Assignment Approach
The collateral assignment approach allows the employee the benefit of ownership of the life insurance policy. Under this approach, the employer pays the premiums and the employee owns the policy either directly OR an irrevocable trust may be established. Under this split dollar life insurance arrangement, the employer retains a security interest in order to be repaid.
With this approach, because the employee owns the policy, it is most common under current tax laws to structure the arrangement so the employer “loans” the amount of the premiums to the employee. Each year the premium payment is treated as a separate loan. Loans can be set up either as a term or demand loan and must have an adequate interest rate pursuant to the AFR.
Current AFR rates as of March 2025:
- Short-term (โค3 years): 4.22%
- Mid-term (>3 to 9 years): 4.76%
- Long-term (>9 years): 5.11%
The interest rate; however, may be below market and should depend upon how the arrangement is drafted and how long it will remain effective.
Two Key Benefits of the Collateral Assignment Approach
Two asset protection benefits are, one, that an irrevocable trust may be set up for the employee to own the policy, such as an irrevocable life insurance trust OR another type of grantor trust, and this can assure that the policy will not be included in the employee’s taxable estate for split dollar estate planning purposes.
The second asset protection benefit is that the policy will not be deemed as owned by the employer-business entity and thus will not be within the reach of the business’s creditors.
Emerging Split Dollar Strategies for 2025
Several newer approaches to split dollar planning have gained traction in the last 24 months:
Modified Endorsement Arrangements
These new hybrid structures combine traditional endorsement features with selective loan features for greater flexibility. This approach is particularly valuable when policy performance fluctuates or when business conditions change during the arrangement.
Family Private Split Dollar
Using split dollar between family members rather than in business contexts has grown recently, particularly for multi-generational planning. This approach moves beyond the traditional employer-employee structure to facilitate tax-efficient wealth transfer.
Multi-Participant Pooled Arrangements
These consolidated split dollar plans cover multiple executives under a unified structure to minimize administrative costs. Particularly valuable for professional service firms with multiple partners or key employees.
Split Dollar Life Insurance Taxation Concerns
Split dollar plans are closely monitored for changes in the tax laws that could adversely affect these plans. In 2003, the IRS endeavored to restrict split dollar plans dramatically by creating an “economic benefit regime“.
Economic Benefit Regime
What this means is that the IRS rules look at the economic benefits accruing to both the employer and employee when analyzing the tax ramifications of the plan and then allocate taxes accordingly. In theory, this is why a loan approach has become preferable since 2003, because if a loan is used, then little economic benefit is being realized by the employer OR employee concerning the payment of premiums. Similarly, this is why the employee is only paying the amount of applicable term insurance if they are only receiving access to the death benefit while the employer has access to cash values.
The IRS has conducted more audits of executive compensation arrangements including split dollar plans in 2023-2024 compared to 2020-2021. This increased scrutiny makes proper documentation and annual administration more vital than ever.
Poor Planning Consequences
It is very important to cover all aspects of your split dollar plan in detail, because a poorly conceived plan can be “unwound” under the IRS rules and this can lead to major tax consequences for the estates of either the employer or employee.
The Tax Court’s 2024 ruling in “Robertson v. Commissioner” reinforced strict adherence to economic benefit valuation methods, resulting in significant tax assessments for improperly structured arrangements.
Also, this article is just scratching the surface of the tax issues that can arise, because if family trusts are used, or buy-sell agreements are involved, numerous tax considerations are brought into the picture. This is therefore, definitely an area that warrants substantial professional counsel.
Real-World Case Study: Medical Practice Succession
Note: The following case study is a composite example based on typical arrangements and does not represent any specific client or practice, but illustrates how split dollar structures work in real-world situations.
Client Profile:
- Dr. Barbara Chen, 57, owner of Metropolitan Neurology Associates
- Practice value: $4.2 million
- Annual personal income: $925,000
- Objectives: Practice succession planning, tax-efficient wealth transfer, key physician retention
Challenges:
- Two junior partners (ages 42 and 45) identified as succession candidates
- Need to fund potential buyout within 5-7 years
- Desire to minimize practice cash flow impact
- Concerns about tax efficiency of the arrangement
- Need for flexibility if succession plans change
Solution Implemented:
- Modified loan regime split dollar arrangement using $3.5 million whole life policy
- Annual premium: $175,000 for 10 years
- Practice pays premiums and books as a loan to Dr. Chen
- AFR-based interest accrues but payment deferred
- Collateral assignment structure with irrevocable trust as owner
- Special provisions for practice access to cash value if needed for succession funding
Financial Outcomes:
- First-year cash value: $148,000 (85% of premium)
- Year 5 projected cash value: $945,000
- Loan balance at year 5: $984,000 (including accrued interest)
- Expected policy IRR at year 10: 4.8%
- Tax impact: Annual economic benefit cost to Dr. Chen of only $8,750 in year 1
Succession Impact:
- Created defined funding mechanism for future buyout
- Established incremental ownership transition timeline
- Reduced succession tax burden by approximately $420,000
- Protected practice from disruption in event of Dr. Chen’s disability
- Provided incentive for junior partners to remain with practice
Terminating Split Dollar Life Insurance Plans
Split dollar plans usually terminate upon an event specified in the contract, such as retirement, OR upon the employee’s death. If the employee fulfills the requirements of the loan (under a loan agreement) then all restrictions are released on the policy. Under an economic benefit arrangement, the policy would be transferred to the employee and the employer would be compensated pursuant to either the “equity” or “non-equity” approaches discussed above.
Current best practices for termination include developing clear exit strategies at the outset of the arrangement. This includes defining triggering events beyond retirement and death, such as:
- Key employee resignation
- Business sale or merger
- Policy underperformance thresholds
- Change in tax laws affecting the arrangement
Early termination consequences should be carefully documented, especially regarding the calculation of amounts due from either party and the timing of payments.
Selecting the Right Policy Type for Split Dollar Plans
When designing a split dollar arrangement, choosing the appropriate insurance product should be driven by the specific needs and objectives of both the business and the key employee. Different policy types offer distinct advantages that may align better with certain situations.
Split dollar plans are more complicated than executive bonus plans, as discussed, yet the benefits to employers are very similar. Funding a split dollar plan is a way to reward a key employee while creating a funding mechanism that can serve various business purposes.
This funding can be used for a future buyout or even a deferred compensation plan. The key is matching the policy characteristics to your specific objectives.
Policy Considerations for Split Dollar Arrangements
Traditional Whole Life Insurance
Dividend Whole life policies offer:
- Guaranteed cash value growth that can provide certainty for planning
- Non-fluctuating death benefits
- Potential dividend participation
- Predictable premium obligations
These features may be particularly valuable when certainty and guarantees are the primary concern, such as when funding specific known future obligations.
Indexed Universal Life (IUL)
IUL policies provide:
- Potentially higher cash value growth linked to market indices
- Downside protection with minimum guaranteed interest rates
- Premium flexibility that can adapt to business cash flow changes
- Often lower initial costs
These characteristics may better serve arrangements where premium flexibility and growth potential are prioritized over absolute guarantees.
Variable Universal Life (VUL)
VUL policies can be appropriate when:
- Maximum growth potential is desired
- The business and employee have higher risk tolerance
- Investment control is important to the participants
- The arrangement has a very long time horizon
Aligning Policy Selection with Arrangement Goals
The most appropriate policy type depends on several factors:
- Time horizon of the arrangement
- Need for premium flexibility vs. premium certainty
- Importance of guaranteed vs. potential growth
- Risk tolerance of both employer and employee
- Exit strategy considerations
For arrangements with defined short to medium-term objectives and less tolerance for variability, more guaranteed products may be appropriate. For longer-term arrangements where growth potential is prioritized over guarantees, IUL or VUL products might better serve the participants’ interests.
Each split dollar arrangement should be custom-designed with the policy type selected based on an objective analysis of all these factors rather than a predetermined preference for any particular product type.
Frequently Asked Questions About Split Dollar
How do the 2003 split dollar regulations impact arrangements today?
The 2003 regulations established two tax regimesโeconomic benefit and loanโthat continue to govern split dollar arrangements. These regulations significantly impacted valuation methods and tax treatment. Current arrangements must be carefully structured to comply with these regulations, which the IRS continues to enforce with increasing scrutiny.
What is the difference between loan regime and economic benefit regime?
In a loan regime arrangement, premium payments are treated as loans from the employer to the employee with interest based on AFR rates. In an economic benefit regime, the employee is taxed on the value of the economic benefit received (typically the term insurance cost or access to cash value). The loan regime has become more popular as it often provides more favorable tax treatment.
Can split dollar be used in an S corporation?
Yes, split dollar can be used in S corporations, but special considerations apply. Since S corporations are pass-through entities, the tax implications differ from C corporations. Benefits may be treated as distributions to shareholders rather than compensation. Care must be taken to properly document the arrangement to avoid unintended tax consequences.
How are split dollar arrangements taxed for the employer and employee?
For the employer, premium payments are generally not tax-deductible unless structured as part of an overall compensation plan. For employees in economic benefit arrangements, the value of the current life insurance protection is taxable income. In loan regime arrangements, the employee may need to recognize imputed interest if below-market interest rates are used. The specific tax treatment depends on how the arrangement is structured and documented.
What happens to a split dollar arrangement upon the employee’s retirement?
Retirement typically triggers termination provisions in the split dollar agreement. Under a loan regime, the employee might repay the outstanding loan plus interest from policy values or other assets. In an economic benefit arrangement, the policy might be transferred to the employee with the employer receiving compensation for its interest. A well-designed agreement will clearly specify all termination procedures, including timing and valuation methods.
Conclusion
Split dollar life insurance plans continue to provide valuable benefits for small and medium-sized businesses looking to incentivize key employees while maintaining control over costs and benefits. The flexibility of these arrangements allows for customization based on specific business goals and employee needs.
With the increase in IRS scrutiny and the evolving tax landscape, proper documentation and ongoing administration are more critical than ever. The strategic use of either the endorsement or collateral assignment approachโor the newer modified structuresโcan provide significant advantages when aligned with overall business succession and tax planning goals.
If you would like more information regarding how split dollar life insurance fits into your small business planning, please give us a call today for a complimentary strategy session. With the recent changes in tax regulations and the increased audit activity, now is an excellent time to review existing arrangements or explore implementing new ones with proper guidance.
