Employee Retention Strategies: Endorsement Split Dollar Arrangement
Last month, we looked at how to implement REBA and the significant advantages available for both the employer and a key employee. Our second strategy is split dollar — one of the most popular and efficient strategies used by employers to provide unique fringe benefits for their key employees. Split dollar refers to an arrangement in which a life insurance policy’s premiums, cash values and death benefit are split between the insured employee and the employer.
How It Works
Split dollar plans come in two forms, but our focus is on the endorsement type.
With an endorsement split dollar arrangement, the employer will own a life insurance policy on the employee. The employer allows the employee to name the beneficiary on some or all of the death benefit by filing an endorsement with the life insurance company.
Each year, the business pays the premium and the employee pays tax on the “economic benefit” associated with the endorsed death benefit, which is at a lower cost to the employee than if they purchased their own life insurance policy. That benefit amount is based on rates contained in IRS Table 2001 or on a carrier’s one-year term rate — both of which are extremely low.
If the arrangement is terminated, the employer removes the endorsement and is then entitled to the entire death benefit. The employer retains full ownership rights including the option to surrender the policy or maintain the policy inforce. However, if the employee dies while the arrangement is in effect, the endorsed portion of death benefit is paid to the employee’s beneficiaries, and any remaining death benefit is paid to the employer.
A typical arrangement contemplates that, after the specified period of time elapses, the employee will be given an opportunity to acquire the policy. Often, the employer’s intent is to transfer the policy as a retirement bonus providing continuing death benefit for the employee’s family in post-retirement years. As with any compensation, such a bonus would be taxable to the employee and deductible to the employer. Note that the employer would also recognize any gain upon transfer, just as with a policy surrender.
The Appeal for Business Owners
This type of arrangement appeals to business owners who want to offer an incentive for key employees to remain with the company but want to retain full control of any assets set aside until a benefit is actually paid.
It can also be attractive when:
- The business routinely keeps significant cash on the balance sheet. Moving some of that cash to a policy insuring a young, healthy employee can result in somewhat higher earnings and earnings that are tax deferred. The business owner is interested in the policy cash values and endorsing the “excess” death benefit to the employee creates a fringe benefit at essentially no cost.
- The business owner anticipates selling the company in the future and will offer a stay bonus to an employee that is critical to the company. The business will own a key person policy so that if the employee dies unexpectedly, there is cash available to locate and recruit someone with comparable skills. The business will set aside funds in the cash value policy to pay the promised stay bonus. Putting an endorsement split dollar arrangement on the policy gives the employee an immediate benefit in the form of preretirement life insurance coverage at minimal cost.
In the endorsement split-dollar arrangement, there are several advantages for both the employer and the executive. Let’s look at the various other benefits.
Benefits for the employee:
- Death benefit protection for employee’s family at minimal cost
- Death benefit proceeds income-tax free to beneficiary
- A written agreement creates a formal arrangement to incentivize a key employee
- The policy can be purchased from the employer if the employee requires death benefit coverage following retirement
- Or, the employer can bonus the policy at retirement to reward the employee for their loyalty and service
Benefits for the employer:
- Business owns the policy and controls the cash values
- Policy cash values are an asset on the balance sheet
- Corporate cash accumulates tax free
- Not subject to ERISA regulatory requirements
- Easy to administer
- Easy to communicate
- Low cost (and an opportunity for full cost recovery)
- Complete discretion as to which employees are selected to participate
- Select the amount of death benefit endorsed to different employees
- Flexibility to "renew" the arrangement for a new term using the same policy
- At retirement, the employer’s options include:
- Bonus (or sell) the policy to the key employee
- Surrender the policy for its cash value
- Keep the policy as an asset of the business, and eventually recoup costs via the tax-free death benefit
Keep in mind, even though an endorsement split dollar arrangement is not covered by ERISA or 409A, employer-owned life insurance is subject to IRC §101(j) which requires employers to have notice and consent from an employee before a policy is issued in order to keep the death benefit tax free.
This is just an overview of a popular key employee retention strategy that may appeal to your business owner clients. Keep this idea in mind as you talk with your business owner clients about their concerns about retaining their best, most talented employees. Your Ash Advanced Markets team is ready to provide you with the expertise and support to successfully present this or other strategies so you can bring a solution to your clients. Reach out at (800) 589-3000. And keep an eye out as we cover our third and final strategy — employer funded deferred compensation.