A. Split-dollar life insurance recently became famous because University of Michigan (U-M) and its head football coach Jim Harbaugh were reportedly reached an agreement.
What is split-dollar life insurance?
1. In essence, a split-dollar has two parties who by agreement share in the rights and obligations of a life insurance policy. In the U-M and Harbaugh case, the two parties are the employer (U-M) and the emploee (Jim Harbaugh). The policy premiums, cash value, and death benefit are shared or "split" between UM and Jim Harbaugh.
2. Split-dollar brings together the life insurance needs of an employee with the premium paying ability of the employer. The employee gets the life insurance protection they need at an affordable cost while the employer gets to pick and choose participants and can be reimbursed for the cost of the plan.
How does split-dollar insurance work?
We will use the U-M and Harbaugh case to illustrate:
1. Starting in 2016, U-M pays six annual life insurance premiums of $2 million. The death benefit is estimated to be $75 million.
2. Harbaugh owns the policy subject to a collateral assignment in favor of U-M.
3. Essentially, U-M is providing Harbaugh with an interest-free loan of the annual life insurance premiums.
4. Each year Harbaugh must include an interest charge with his income. In essence, it is treated like compensation. But the income amount and the resulting tax is much smaller than the premium amount.
5. If Harbaugh dies while the agreement is in force, U-M gets its premiums back through the death benefit split. Harbaugh's beneficiaries get the remainder.
6. If Harbaugh is fired or quits, U-M exercises the collateral assignment and gets its premiums back through the policy cash value. After the assignment is removed, Harbaugh keeps the policy, including any remaining cash value. This provision motivates Harbaugh to stay with U-M.
7. After the six-year period the agreement may end and U-M will be reimbursed for its premiums paid (from the policy value). However, the plan allows for amendments, for example, if the relationship is going well, the parties could extend the agreement beyond six years.
8. In the end, the only cost to U-M is the opportunity cost on the premiums. Harbaugh's cost is the annual income he must report, although modest compared to the premiums.
A split-dollar life insurance is commonly used in the business community, and is appropriate for executives, officers, and managers. It can be established for a single participant or for a group of employees.