It sounds simple. But determining whether to take advantage of this window of opportunity is anything but. Indeed, because split-dollar policies are notoriously complex, be prepared to sit down with the financial advisers who crafted your arrangement and crunch some numbers.
Typically, split-dollar policies work like this: A company buys a life-insurance policy on a senior executive and pays the premiums. Then, at some point -- often retirement -- the employee reimburses the company for the premiums, taking sole ownership of the policy. The policies provide two benefits. One is life insurance. The other is the cash value that grows as the premiums are invested by the insurer. Once the cash value exceeds what's required to repay the premiums, employees can withdraw or borrow against it. It's this cash value, historically tax-free to the employee, that now faces taxation, says George Cushing, partner at Kirkpatrick & Lockhart in Boston.
If you've got a split-dollar arrangement, first ascertain whether your policy has any cash value. If so, calculate how much tax you'll owe. Consider an executive with $5 million of life insurance. If the policy has $1.6 million in cash value and $600,000 has been paid in premiums, $1 million will remain once the executive reimburses the company. At today's top income-tax rate of 35%, the potential tax hit on that profit is $350,000. (The timing of that tax bill will depend on when the policy was established.)
To escape the tax bill, the executive can terminate the split-dollar arrangement and reimburse the employer for the premiums. To do so, employees can either cash in their policies or -- if they'd rather keep the insurance -- dig into their own pockets. To qualify for this treatment, though, the policy has to have been in place before Jan. 28, 2002.
For policies established after Jan. 28, 2002, but before Sept. 17, 2003, the tax treatment is less clear. The IRS may ultimately impose tax on the cash value, says Susan Lennon, a director in the human resources services group at PricewaterhouseCoopers. But the agency "hasn't yet issued final public guidance," she adds.BAILED OUT WITH A BONUS?
If your policy was established after Sept. 17, there are two possible outcomes. If your company owns the policy, both the insurance protection and cash value will be subject to tax. But if the employee owns it, the IRS will treat the premiums paid -- $600,000 in the above example -- as a loan from the company. The downside to a loan, of course, is that you'll owe interest. But you'll escape tax on the cash value. To help executives meet these costs, some companies are doling out bonuses, says Catherine Keating, a wealth adviser at JPMorgan Private Bank.
Even if your arrangement was around before Jan. 28, 2002, you may want to convert it to a loan by Dec. 31, rather than terminate it. Why? Perhaps you need to keep the insurance, but cannot afford to repay the premiums. Indeed, with interest rates so low, you might pay less by taking out a loan than by paying tax on the cash value. One caveat: If you work for a public company, the recently passed Sarbanes-Oxley Act prohibits corporate loans to certain top execs. If you fall into that category, you might seek a bank loan instead.
If your split-dollar policy has no cash value, it makes little sense to terminate it. But you'll need to monitor the cash value and plot your exit strategy, says Mark Teitelbaum, second vice-president of Travelers Life & Annuity (C
) because nothing about split-dollar life insurance is simple, consult with an expert. But don't take too much time: Your window to secure a potentially large tax break ends on New Year's Eve.
Corrections and Clarifications
"Deflecting a blow from Uncle Sam" (Personal Business, Nov. 3) stated incorrectly that employees can cash in split-dollar life insurance policies and avoid taxes. The story should have said that to get a tax break, employees need to hold on to the policies and reimburse their employers for the premiums
By Anne Tergesen