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With the economy nearing overdrive, companies are working overtime on creative ways to retain key executives and attract talent from competitors. One method gaining in popularity is offering a sizable life insurance policy tied to the employees remaining with the firm. As explained by Trip Beattie, a veteran San Diego insurance broker, these "split dollar" agreements work something like this:
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Suppose someone holds up a dollar and tears off a tiny strip. Pushing the small piece toward you, that person says, "This is what you pay." Then, as the big piece is shoved toward you, you’re told, "This is what you get paid." For companies in recruitment mode, that split-dollar addition to the package may be the factor that swings the decision to come here, says Beattie, of Trip Beattie & Associates.
Different approaches to using life insurance also are widely employed. The generally small size of San Diego-area companies may make split-dollar agreements for life insurance more popular here than in other areas. Big companies appear less interested in the insurance as a tool.
"I’m not aware of split-dollar being used extensively by any large corporations," says Dick Norton, a life products specialist in Prudential's Woodland Hills office.
In addition, certain legal questions about split-dollar haven't been resolved. Many people have accepted the position that when a split-dollar agreement is terminated and the policy is fully owned by the executive, the cash value transferred to the executive is not taxable. "That's a very hotly debated point," Norton says. "Our attorneys do not favor that belief."
But other lawyers and organizations do accept that position, and there have been no court cases to settle the dispute. "It just kind of goes on," Norton says. "Nobody really wants to mess with it too much."
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Veteran insurance broker Trip Beattie discusses
split-dollar agreements.
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The 'Golden Handcuffs' Allure
More popular for executive compensation, reports Norton, are non-qualified deferred compensation plans and executive bonus plans, both of which use life insurance as a funding vehicle because of tax advantages that accrue for the executive and the company.
Deferred compensation, one of several plans that are known as "Golden Handcuffs," is based on an unsecured promise by the company to pay the executive after a period of time. The package includes a sizable life insurance component.
The executive is encouraged by such promises to stay long enough to get the package, and also to help the company prosper. "So it’s the promise of this gold down the road that keeps their eye on the ball, so to speak, doing the right thing to help the corporation up to and beyond the date of retirement," Norton says.
Insurance policies also are used in the payment of executive bonuses because they can be a way for executives to get needed insurance without having to pay the full cost themselves. Under a bonus plan, Norton says, the executive would own the life insurance, while the company would pay the premium as a bonus, reporting it as additional income to the executive, and then perhaps even offsetting any additional taxes with a salary increase.
In San Diego, life insurance sales using the split-dollar concept are growing, in the experience of Beattie and others. And it seems nobody loses except Uncle Sam's tax collectors.
"Split-dollar" refers to the method of dividing benefit payments, and the insurance can take numerous forms. The flexibility allows emphasis of various features.
Premiums on that form of life insurance are "quite high," Beattie says, because the idea is to quickly build future value for executives already so well paid that they don’t immediately need more cash. By high premiums, Beattie means ones that could run to $50,000 a year, perhaps much higher. Premiums of only $10,000 per year or so would be unusually low.
Before members of your executive compensation committee choke on their sushi, it should be added that the insurance is commonly structured so that the company is reimbursed for all it paid in premiums, or even more, says Beattie, a Chartered Life Underwriter, the equivalent of a CPA designation for insurance people, and a member of the National Association of Life Underwriters.
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Eric Gardiner, a San Diego agent with Northwestern Mutual Life Insurance of Milwaukee, gives the hypothetical case of an executive greatly valued by his company, which promises him a large sum if he stays a certain period. Under a split-dollar agreement, a policy is purchased by the company, with the company paying premiums of $50,000 per year. The insured executive, who must have a financial interest in the policy, would be required by IRS rules to pay perhaps $1,800 in premiums for his share of the economic benefit. To make up even that small expenditure most companies simply "gross you up," Gardiner says.
The premiums are invested and, being life insurance funds, all the growth is tax-deferred. The executive's spouse is well protected, an important factor in executive relocation decisions, he says.
Split-dollar life insurance, Gardiner contends, "is quickly becoming a very important part of corporate America."
Three events trigger access to the accumulated money, points out Larry Showley, a broker with 30 years experience who holds the CLU designation and also is a member of the elite 1,600-member Advanced Association of Life Underwriters: "The executive can die, retire or quit."
Exactly what happens to the money depends on how the contract is structured. When writing such a policy, the first step is to determine who will own it.
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Agent Eric Gardiner
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The insured executive can own it, in which case the policy would be assigned to the company. Or, the company can own it and assign it to the executive, says Showley, of Showley, Archambault, Alexander & Kelly.
The second method is the one often used to give the executive an incentive to stay with the company over a long period. It is one of those sometimes called a Golden Handcuff.
CPA Charles Pope calls split-dollar
agreements a 'good deal.'
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Charles Pope is a certified public accountant with Gatto & Pope, whose clients often use packages with split-dollar agreements for life insurance. He sees few disadvantages for anyone.
"It would seem like there's no real downside," he says. "The downside for the corporation is that if they were to pay out a salary, they would get the deduction for it. They're sacrificing a little bit there, but for the executives certainly it’s a great deal."
Growth in such uses of life insurance are in part a result of changes in the insurance industry, Pope says.
"There are probably more insurance agents around, and they understand their products better, and they're pushing their products better, and insurance companies are doing a better job of looking at different ways to sell insurance," he says. "This is one of the ways they're pushing the insurance product — it opens their market up to other areas."
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Contracts that involve split-dollar life insurance are endlessly complex. The insurance concepts may come from a broker or agent, but the contracts always require the oversight of a CPA and must be drafted by a lawyer who specializes in the area. A disinterested insurance consultant also is a good idea.
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James Lauth, a lawyer with Beamer, Lauth & Steinley, says the executive also needs his own lawyer to help with avoidance of estate taxes. For example, if the employee must continue to work as a condition of the insurance staying in effect, some estate planners believe that makes it impossible to get the proceeds out of the taxable estate. "Insurance is an incredible vehicle in terms of both income-tax and estate-tax savings, but it needs to be done carefully and properly," Lauth says.
Other legal aspects, too, can be tricky. An IRS technical advisory memorandum in the spring of 1996 temporarily dimmed the enthusiasm for split-dollar contracts for life insurance, Beattie says.
The seven-page memo ruled that a particular executive, being compensated |
Attorney James Lauth cites need
for estate tax awareness.
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under an unusual contract, could be taxed on proceeds from a policy. Although not all aspects of the ruling have been resolved, it now appears that it applies only to that one case, he says.
Showley, too, cautioned against such mistakes as writing a contract under which the executive could get money at any time. That would cause the employee to be taxed currently, "and that’s what we want to try to avoid."
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