by Karen Murphy, MostChoice.com

Split dollar funding techniques usually refer to arrangements by which premiums, cash values and death benefits of a regular insurance policy are split by two or more parties. They are considered one of the least expensive and most effective methods to help fund a buy-sell agreement or to bring younger owners into a closely held corporation. 

Split dollar funding can benefit your company and favored employees including owner/ employees and designated heirs by helping an individual obtain life insurance at a cost lower than would otherwise be possible. It also gives business owners an opportunity to significantly increase the value of their estates with minimal income tax consequences. 

Using Split Dollar Plans to Fund Buy-Sell Agreements

Buy-sell agreements can help you avoid the majority of business continuation problems facing today's business owners. These agreements ensure the orderly transfer of the deceased's business interest to key employees, business partners, co-shareholders or heirs at fair values determined in advance of the business owner's death.

Once a buy-sell agreement is established, a means is needed to fund the eventual buyout. Split dollar life insurance is cost-effective way to fund business continuation plans. Although the premiums are nondeductible, the death benefit proceeds are income tax free.

There are four different methods of split-dollar funding techniques:

• Collateral assignment -- The employee owns the policy and names a personal beneficiary. The employer pays the nondeductible premiums for the policy. The policy's death benefit and cash value is assigned to the employer as collateral for the employer's interest. 
• Endorsement -- The employer owns the policy, and the employee receives a portion of the policy's death benefit. The employee's death benefit portion is the amount equal to the total policy death benefit less the greater of the policy cash value or the premiums paid by the employer.
• Split ownership -- The employee owns the policy, and the employer has specific rights to the policy. The employee's personal beneficiary receives the death benefit in excess of the employer's interest in the policy. The employer's death benefit interest is typically the amount of the premiums paid.
• Sole ownership -- A third party owns and is named the beneficiary of a policy that insures the life of the employee who is a majority stockholder. No assignment or endorsement is used, thus the company has no corporate rights to the policy. 

Split Dollar Plans for Business Succession

When arranging for the transfer of a business from an older generation to the younger, the cost of the insurance is split between the corporation and the younger members. The older members of the corporation are the insureds and the younger members are the applicants and owners of the policies. The corporation pays the bulk of the premium each year. These premiums are not deductible. 

Collateral assignments, signed by the younger members, guarantee that the payments made by the corporation will be returned to it at the death of an insured family member. The proceeds paid at death to the business are income tax free. At death, the younger members are paid the difference between the face amount of the policy and the company's premium investment.

In addition, there is a yearly taxable benefit to the younger members. This benefit is the portion of the premium that represents the cost of one-year renewable term insurance.

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