By Dr. Jim Dahle, WCI FounderI get an email a couple of times a year from a doctor asking me to evaluate a benefit his hospital is offering him called “split-dollar” life insurance. I hate these stupid things. The first reason I hate it is that just to tell you why I hate it I will first have to spend hundreds of words explaining to you what this thing is and how it works.
I'm convinced that almost nobody understands how this works. I don't think the employer understands it. I don't think the employee understands it. And I'm not even convinced that the guy selling it (and yes, there is a guy selling it) understands it any further than how much commission he will be paid to sell it.
There are so many moving parts here and so much flexibility that a talented insurance salesman has a plethora of ways to hide what is really going on. So I think it is important to start, right here at the beginning, and tell you what is really going on.
For example, suppose your goal is to retain a really good employee. What are the possible ways you could do so? Well, you could treat her really well. You could also pay her really well. You might even offer a nice set of benefits. The benefits are even better at retention if they somehow place golden handcuffs onto the employee. Examples of this include vesting of the 401(k) match or stock options that gradually vest. Those are pretty straightforward benefits, however. Basically, you're just getting paid more money if you stick around. Very simple. The employer doesn't have to spend time and money hiring and training someone else and the employee gets paid what they're worth without having to go find another job.
However, once you get beyond these sorts of straightforward “show me the money” benefits, the value of a benefits package comes down to whether or not the employee would buy this thing on their own if the employer didn't provide it. The best benefits are those the employee cannot get herself (such as a retirement plan like a 401(k)) or which the employer can often provide cheaper than the employee can buy it on the open market, such as health insurance. But if you sat around and thought about which benefits you would rather an employer provide you rather than just paying you more, the list would likely be very short and a cash value life insurance policy would probably not be on it.
Employees don't actually want these things. How many of you when you interviewed for a job asked “Is there a split-dollar life insurance plan?” If that number isn't 0%, it certainly rounds there. So why in the world would an employer see giving employees something they don't want as a way to retain them? It doesn't make any sense, except once you consider what is going on, which is:
Sounds straightforward enough right? That is until you add it to one of the most complex financial instruments out there — a universal life insurance policy, which just became an order of magnitude more complex. Wondering why you, as a smart person, are having a hard time wrapping your head around all of these moving parts? Do you think this complexity favors you or the person designing the policy? I'll give you two guesses and the first one doesn't count.
There are typically two arrangements here. Let's go through them one by one.
#1 Economic Benefit Plan
If the employee leaves the employer, one of two things happens.
- The policy is surrendered and the cash value goes back to the employer or
- The employee becomes the owner of the policy. If the employee buys the policy from the company, she pays the employer the cash value and again the employer is made whole. Alternatively, the employer gives the policy to the employee (usually with some vesting requirements) and the cash value of the policy becomes a tax deduction to the company and fully taxable income to the employee.
This is considered a “non-equity” arrangement, where the employee (really their beneficiary) only gets a portion of the term life insurance death benefit. So what are the benefits of this arrangement in the event the employee dies?
- Insurance agent: Gets a big fat commission
- Employer: Gets to provide discounted (50-70% off) ART life insurance to the employee, hopefully retaining them longer as a result. The employer doesn't have to offer this to all employees as it isn't covered by ERISA law. The cash value grows tax-deferred too so the employer gets a low return on their cash.
- Employee: Gets to feel good about having a life insurance policy for their beneficiary.
- Beneficiary: Gets almost all of an ART life insurance policy death benefit
So the benefit for the employee, at least in the first few years, is that they get almost all of an ART life insurance policy death benefit for 20-50% of the real cost. The benefit for the employer is that his only cost is the opportunity cost of the money that went into the policy since he was made whole at death.
Sounds pretty good right? So what is the problem? Well, let's say the employee doesn't die and the employer does NOT gift the policy to the employee at separation. Who scores under this scenario?
- Insurance agent: Still gets a big fat commission
- Employer: Ended up with an investment with a crummy return
- Employee: Gets to know he had life insurance just in case. Also has the option to buy a universal life policy if he still has a life insurance need and is no longer insurable.
Is the employee really going to stay in a job she doesn't like for that benefit? Probably not.
What About an Equity Arrangement?
Still not confused? Great. Let's make it even more complicated. We're still in the “Economic Benefit Plan” category, but instead of having a non-equity arrangement, where the employee is only entitled to part of the death benefit, let's make it an equity arrangement where the employee also gets some sort of access to the cash value. Now the employee can borrow against the cash value or even possibly withdraw some of it as a partial surrender. This option presumably only shows up in plans where the employer is planning to give you the cash value anyway, otherwise, you would have to pay the loan back at the time of company separation. Obviously, borrowing against a life insurance policy is tax-free but not interest-free. Partial surrenders are great. There is obviously going to be less life insurance then, but you can take the cash and do whatever you want with it. However, instead of it being tax-free as it often is with a cash value life insurance policy since it represents premiums paid, these partial surrenders are fully taxable at ordinary income tax rates since it is a form of compensation to the employee. If it is just going to come to me as fully taxable income anyway, why not just pay it to me as a cash bonus? Yes, it was growing in a tax-protected way, but it was at such a low rate of return it's hard to get excited about that. I would have rather had the money and been able to invest it in traditional investments instead of having it stuck in a life insurance policy. Lots of moving parts here.
So who scores under this version where the employee vests into the cash value over 5 years, then separates from the employer without dying?
- Insurance agent: Still gets a big fat commission
- Employer: Gets nothing other than possibly encouraging an employee who doesn't understand what is going on to stick around longer.
- Employee: Has part of her compensation tied up for 5+ years in an investment with a crummy return. Not exactly the same as stock options for Google employees.
As you can see, the person who really makes out well here is the insurance agent. Thus, we see what is going on:
#2 Loan Plan
But wait, there's more. Instead of an economic benefit arrangement (either non-equity or equity), you can also have a “loan arrangement,” or “collateral assignment” or “split-dollar loan” or “loan regime.” In this plan, the employee owns the policy and pays the premiums instead of the employer. The employee still chooses the beneficiary. However, the employee pays the premiums using money loaned by the employer.
Yup. As if it wasn't complicated enough before, now we're adding a loan to the mix. The employee has to either pay interest to the employer on the loaned funds or more commonly, pay the taxes due on this interest being forgiven. The interest rate can at times be below current market rates if interest rates have risen since the policy was put in place. So the agreement is usually written such that if the employee dies the employer is made whole from its loans by the death benefit and the rest of the death benefit goes to the beneficiary. If the employee separates, one of two things happens depending on how the agreement is written:
- The employer is made whole by the employee. If the employee wants to keep the life insurance policy, she can make the employer whole using other funds, but I suspect most of the time the policy is surrendered to make the employer whole.
- The employer forgives the loans, at which point the amount forgiven becomes a deduction to the employer and taxable income to the employee.
Even more complicated, but really just a variation on the themes above.
Whew! 1900 words so far and you're just now starting to wrap our heads around this thing. Let's get into the questions that most people have about these plans.
Should You Take an Offered Split-Dollar Plan?
Let's say you're an employee or a prospective employee and you're being offered this plan. Should you take it? Obviously the devil is in the details since every one of these policies and contracts is unique. But most of the time the answer is yes. I'm no big fan of cash value life insurance, but if someone else is going to buy a policy for me, I'm certainly going to take it. These policies aren't great investments, but they do have value. Worst case scenario, you get the equivalent of a very discounted term life insurance policy. Now if you have zero need for term life, maybe even that isn't a great deal but hey, leave it to your mother, niece, or favorite charity. However, I would do one other thing before I took the plan. I would ask the employer if they would just give me a higher salary (or more CME dollars or some other benefit I valued more) instead. The answer is usually going to be no, but it doesn't hurt to ask.
Should You Keep the Policy After Separation?
One of the worst parts of getting involved in these plans is that at some point you are probably going to be faced with a difficult decision — whether or not to keep the policy in force after you separate from the employer. That usually means you are now taking over the entire premium, so it's no longer the freebie it used to be. However, the crummy return years may now be water under the bridge. That would likely be the case if it were a whole life policy.
However, these policies are usually universal life policies and one unfortunate feature of a universal life policy is that the cost of insurance increases each year as you age. More and more of your premium each year is eaten up by the cost of the insurance, which is basically the cost of an annually renewable term policy. At a certain point, the cost of the insurance exceeds the premium and starts eating into the cash value. If you live a long time, the “investment component” of the policy hasn't performed very well, and especially if you've borrowed a bunch of money against the policy, the cost of the insurance can eat up the entire cash value and you may have to either start paying huge premiums to keep the policy in force or surrender the policy, lose the insurance you were counting on, and maybe even be stuck with a huge tax bill.
So as a general rule, the face amount on a universal life policy is decreased throughout life to minimize the cost of the insurance. People really aren't buying these things for a big life long death benefit. If for some reason you really want a big life long death benefit, you're probably going to want either a whole life policy or at least a guaranteed universal life policy, but those are not common in split-dollar life insurance arrangements.
So what are the circumstances where you might want to keep this policy (or buy it off the employer)? Well, if you really need the life insurance you should probably keep it. Maybe you're not financially independent and you're uninsurable for example. You might also keep it for a little while if you expect to be in a high tax bracket for a few more years and then in a lower one. Maybe you surrender it for an ordinary income tax gain in a lower-income year. Maybe you just really like the value proposition of a cash value life insurance policy (something with a low return that you can borrow against that gets pretty good asset protection in many states and provides some sort of death benefit).
Should an Employer Offer This Benefit?
This question has never been brought to me before, but I think it is the most important one in this post. I think the general answer here is “no.” I don't think it is a great benefit. I think you're better off offering something your employees will value more, at least those who understand what they are really getting. Remember the key point of this post:
Are There Special Circumstances?
As usual with a cash value life insurance policy, there are some special situations where its value might be quite a bit higher for an individual than it is for the general population. Consider somebody with an estate tax problem, for instance. In this situation, the cash value life insurance policy can be placed into an Irrevocable Life Insurance Trust (ILIT), so in essence, the employee's “retention bonus” is now paid directly to her heirs and stays out of her estate. While state estate tax exemptions can be lower, very few physicians will ever have an estate larger than the federal estate tax exemption and thus this technique is not a significant benefit for the vast majority.
The Bottom Line
Overall, I'm not a fan of this method of compensating employees and I hate that so many doctors are now having to waste their time trying to understand how this benefit works. If you are an employee and you are offered this, you should probably take it if you can't talk the employer into giving you something better. Most should also plan to convert any “equity” they have in it to cash by surrendering the policy within at least a few years of separating from the employer. If you are an employer, you need to realize that
Have more questions about life insurance and what kind of policies would be best for you? Hire a WCI-vetted professional to help you sort it out.
What do you think? Have you been offered one of these policies as an employee? How did it work out for you? Have you, as an employer, been approached by an agent to put this sort of a plan in place for your group or hospital? What did you end up doing?
The White Coat Investor may receive compensation from White Coat Insurance Services, LLC; licensed in all states including MA and DC; CA license #6009217; NY license #1758759 (exp. 6/2025); Registered address: 10610 S. Jordan Gateway, #200 South Jordan, UT 84095. This does not affect the cost or coverage of insurance.
Wow…complicated to say the least.
I’m glad I didn’t have to navigate this with my new job but so helpful that you laid this out for those who do!
The Prudent Plastic Surgeon
First of all, I am an independent agent that servicing different type of solutions that suit client best.
Secondly, in my opinions, it was a good article to read about the retention & recruiting program. At first, it is depend on how the life insurance is being designed & the riders are come with it. I cant speak about the policy without reviewing it.
The reason i am writing this comment is because i am servicing one unique retirement program that can be used for recruiting & retention key talent too. But it is totally different design than the article above. This program can be very beneficial for either individuals or businesses. Allow me to briefly summarize it.
This program is a Bank matching 3-to-1 premium life insurance program. This is NOT a traditional premium financing program. Here are a few the advantages & disadvantages as follow:
Advantages:
1) bank matching fund (3-to-1)
2) client only fund in a small portion for only 5 yrs.
3) no credit check, no loan signature, no equity required
4) downside protect with upside potential
5) tax deferred growth
6)tax free income strategy
7) liquidity
8) living benefits ( heart attacks, strokes, cancer & more)
Disadvantages
1) age 25 – 65
2) qualified health ( if its a group of 15 & up, will be guaranteed issued – no need for health check)
3) household income starts at $100k & up
Thank you for reading my opinions.
Sorry, I’m not going to let you peddle your wares here. Classic example of insurance sales though, listing only advantages and those vaguely without explaining the real downsides. Your “disadvantages” are simply a description of your target audience. Nice try.
Thanks for demonstrating the point of the article though.
A split dollar benefit is offered at our institution (non profit hospital) tailored mainly to high income earners
– contributions are pre-tax. Around 15-18% of it goes towards paying a death benefit for the employer, managment fees, insurance premiumetc
– remaining is invested with return of 0-8% on average, cant go below zero (guaranteed). Accumulates money earned in previous year cant go below zero even if market is down in current year.
– must commit to at least 3 years of contributions (renewable), 5 years preferably for the plan to make for the employee over the long term
– distribution can be taken (tax free) after 3 years at 20% per year (if still employed), or as a lump sump if no longer work for the hospital (tax free).
Basically, a lot MD/Executives are contributing significant amount of their income pre tax, reducing their tax brackets, them pulling out the money after tax free. Are you aware of any similar plan? We were told the plan has been vetted by multiple tax/law firms and such plan is only available for non profit instution.
I could spend all day just analyzing all the various split dollar plans out there. Every one of them is unique. Good luck with your decision of whether to use yours or not. My tips on how to do so are included in the article above.
But your description sure makes it sound like there is a 15-18% “load” on your “investment” to me. Hard to get excited about that unless that cost (and preferably more) is covered by the employer.
In this specific plan, it appears the major benefit is avoiding income tax. If the 15 to 18% “load” on the money going into plan is less than one’s marginal tax rate (which is most likely true), then it seems like a good deal.
One could run the numbers and make a decision about the plan they are presented with, but for me most of it comes down to how much of the premium the employer is paying. Paying a lot? I’ll take it. Paying nothing? I’ll do something else with my money.
Agreed. Definitely need to know the ongoing costs of plan and how much is covered by employer in order to run the numbers. I am still struck by this particular plan and its apparent pre tax contribution and tax free withdrawal (almost like an HSA). I suppose the institution being nonprofit allows for a plan like this.
Like any insurance policy, you need to be careful not to use the words “tax-free withdrawal.” Withdrawals (i.e. surrendering the whole policy) are not tax-free. In fact, any gains are taxed at ordinary income tax rates, not the lower long term capital gains rates, no matter how long you’ve had it. You also cannot tax loss harvest them. So what most people do is borrow against the policy. Borrowing against your policy, like borrowing against your house, is tax-free but not interest-free.
It has nothing to do with the institution being non-profit.
My employer is offering a split dollar cash value arrangement similar to the one above but is paying the vast majority of the fees. It is being pushed as a retirement plan. It is complicated as you mention in the article.
I would like to find an expert to review the policy. Can you provide any names (email or message) of individuals/firms that have expertise and could help analyze the policy and alternatives?
Ha ha. Good luck. If I knew someone who could do that I would have had them write me a guest post instead of doing it myself. Let me know if you find someone.
Few know more about these than the folks who sell them. In my opinion they don’t know as much as they should about them and they have a serious conflict of interest in giving you advice about them.
But you don’t need to know everything about every one of these plans. All you have to know is how yours works and who is paying for most of it. If they are, then it is likely you should take it.
Thanks for writing this article, we just got offered one as well. What do you mean by who is paying most of it? In the example mentioned previously is it the 15-18 percent deducted from your investment? Sorry if the question is too basic but the one we are being offered has this type of fee but then the employer turns around and pays an extra 15 percent of whatever you invest to cover it.
So if you’re paying $100 and they’re paying $15, they’re covering something like 12%. I’d have a hard time getting excited about that. But if they were paying 88%, I’d sure take it.
Thanks for explaining that. What should one compare this investment option against ? The company compares this $100 investment to 60 dollars put into an after tax account. In this view it looks amazing because you skip the taxes on your 100 and it assumes you take loans against your policy in the future and it’s interest free.
As we are all in high tax brackets the difference of pretax money investing and coming out without tax (still don’t understand how this loop hole isnt closed) has a tremendous headstart against taxed brokerage account returns. Even with fees of the IUL cooked into the illustration (they haven’t given the worse case scenario fees to me yet) you come out way ahead.
I appreciate you taking the time to answer these questions, I have spoken to a cfp and an accountant both of whom state it’s a good option but you’re the first who has written such a scathing review of split dollar plans. As I’ve followed you for a while your opinion on things seems to always protect the MD which is why I’m hitting the brakes until I can get a better handle of your point of view.
If my employer gave me the option of this plan or just paying me the money they are putting into this plan, I’d take the money, pay the taxes on it, and invest it in a good investment.
However, for most of the docs being offered this plan, that isn’t an option. So now you’re stuck trying to figure out what this thing is you’re being offered. And every one of them is a little different from every other one. So I literally cannot make sweeping generalizations. It’s just the way the insurance industry wants it. You want to know what you can compare it against. Nothing. You can’t can’t even compare one of these plans against another because every one of them is unique.
But my conclusion was:
So I’m not sure why you think I’ve written a “scathing review” of these plans. I simply explained how they can work. Now it is your job to figure out how the plan you are offered is going to work. Good luck. But the only thing out there that I know of that is tax-free in and tax-free out to you is an HSA. This is tax-free in to you and tax-free out to your heirs. That’s not the same thing. If you cash out of this thing, you’re paying ordinary income tax rates on gains. That’s the way life insurance works.
Sorry scathing was not the right word, thanks for providing counter point to the salesman.
Very well written article and even better comments that follow.
My question to you is this; what if you are the employer and the employee? I am looking at starting a C-corp (21% tax rate currently soon to be 25% +) and have a Management Services Organization (MSO) to manage my other medical and business entities. I do a fair market evaluation to determine my fair market compensation to work for the MSO as an executive (done yearly). My C-corp gets paid the K1 income from the other entities and my normal salary gets paid to me through the C-corp at normal W2 rates. Those leftover C-corp dollars from the K1 contributions for the management of those entities are taxed at 21% (on a Sept-Sept C-corp cycle no less for tax optimization and planning). The leftover dollars can be re-invested, including the dollars you saved from being taxed at 21% instead of the max of 37%+. To get the cash out of there while avoiding the 15% dividend rate for c-corps a split-dollar arrangement IUL policy is created. 100k invested provides 95k cash value after year 1 (and ~2M death benefit). You can pull out the cash value via one of the mechanisms in your article. All the points you make above can be utilized depending on if you want to take the employer (C-corp MSO) or employee position. This seems to be only tax-advantageous if you have K1 income exceeding ~400k/yr.
In this case the employer (C-corp) is paying 100% of the premiums with pre-tax dollars that I (the employee) would then benefit from 100%.
Would love your .02 on this.
The complexity of it all has my head spinning.
Are you sure a C corp is the right entity for your business to start with?
Haha well at least you didn’t blow holes in it like I expected! In this scenario the c-corp is the best option from a tax optimization standpoint. C-corps will always have a more favorable tax rate bc they have so much more powerful lobbying efforts in government. Again, your insights are very much appreciated!
If that’s your only reasoning for a C Corp I fear you may be making a mistake. An S Corp structure has a lower tax burden in many situations (including two of mine) and a sole proprietorship/partnership can even have a lower tax burden in some situations.
As a general rule, when there is a split-dollar life insurance scheme an employer is being sold a policy they probably shouldn’t buy. If you’re the employer, that’s you.
IULs are not great investments, so you have to ask yourself if the additional tax benefits outweigh the crummy investment aspects and additional hassle, complexity, and costs. I don’t think they usually do.
It’s your money of course, do what you want.
Very fair points. Thanks for replying back so quickly.
An email discussion with a “split dollar specialist”:
Agent:
Hi Dr. Dahle,
I am about 4 years late, but just came across an article on why you dislike split dollar in your forum. In the comments you asked if there was a specialist to make guest posts, offer suggestions for what to look for in policies and plan designs, etc. I am happy to have a conversation with you to determine if my knowledge in the space and approach to life insurance funded arrangements in general would offer value to your member community. A few words about my background, I have been designing, implementing, and servicing split dollar arrangements for not-for-profit hospitals for the past 25 years and have been a licensed life agent for 32. My approach to life insurance funded arrangements is to always, without fail, do what is in the best interest of the client, which means structuring policies to minimize internal costs and maximize accumulation opportunities. I am neither asking for nor expect a sales platform. I do believe that I can offer value to your members as a source for an unbiased, objective review of the policy and plan design under consideration. Just let me know if you would like to have a conversation.
Best wishes
Me:
Is there anything that post got wrong? Something that needs corrected? Some reason most employees wouldn’t prefer a higher salary or a bigger 401(k) match instead that I’m not seeing?
We take guest posts: https://www.whitecoatinvestor.com/contact/guest-post-policy/
Agent:
The post isn’t necessarily wrong, but there are some nuances to consider. Split dollar plans can vary significantly based on their design. For example, the differences between recourse vs. non-recourse plans and the timing of rollout/repayment are just two elements where diversity is common. Additionally, the structure of the underlying policy is crucial. For cash accumulation, the policy should be funded at the minimum non-MEC face amount to minimize internal costs as much as possible. Unfortunately, this doesn’t always happen, and physicians may end up with a less efficient policy structure.
You asked, is there “some reason most employees wouldn’t prefer a higher salary or a bigger 401(k) match instead that I’m not seeing?” To answer this, we need to understand why hospitals offer voluntary funded split dollar plans. These plans are designed to exceed the limits of qualified plans and provide additional tax-advantaged savings opportunities. They benefit the hospital because they don’t require a cash outlay; it’s an opportunity made available to employees. The hospital also benefits from reduced payroll taxes and eventually receives repayment of the outstanding split dollar loan, similar to a deferred charitable gift.
Since the split dollar plan is a voluntary arrangement, the options you mentioned—higher salary or a bigger 401(k) match—aren’t as viable because they require additional cash outlay by the organization. Moreover, an increased match isn’t sufficient to make a significant difference. The main advantage of a split dollar arrangement is that it allows contributions beyond qualified plan limits, significantly reducing an individual’s personal tax burden and accumulating funds in a tax-advantaged manner for future use or to increase current cash flow to create investable assets outside of the insurance policy.
Choosing a voluntary split dollar arrangement is like evaluating any other investment opportunity: you need to consider the benefits, costs, and projected value of alternatives. Simply put, if the tax savings significantly outweigh the internal policy costs, the opportunity is worth considering. If the comparison between participating and not participating is relatively neutral, the plan might not be beneficial.
With the flexibility in designing split dollar arrangements and constructing the underlying life insurance policy, the devil is in the details. Hospitals use these arrangements to offer physicians an additional tax-advantaged savings opportunity. Plans usually fail due to poor design or an insurance policy that benefits the agent more than the participant.
Me:
Thank you for the clarifying comment.
Thank you for posting the exchange. Some of us have signed up for this plan at our place of work for exactly the reasons mentioned by the agent (no way to get more 401k match, salary scales “standardized” to whichever metric they choose, and no other vehicles to reduce taxes). I hope this agent will do a guest post to talk about further nuances if there are any.