A NECA split dollar arrangement offers business owners a sophisticated life insurance solution
For successful business owners, purchasing life insurance with corporate dollars can be an effective way to protect their family or to recruit and reward key employees. The following case study shows how a business funded a large life insurance policy through a Non-Equity Collateral Assignment (NECA) split dollar arrangement.
- Male, preferred non-smoker, owns a 45% interest in a C corporation that generates solid annual revenue.
- He wants to provide a minimum of $3M death benefit indefinitely to protect his family, within the following parameters:
- Using cash from the business to pay the premium, with the business recouping its premium cost upon the business owner’s death
- Wants the business to cover the business owner’s personal tax cost, if any, during the premium-paying period (15 years)
- Exiting the arrangement at the business owner’s retirement (age 65)
- Using the policy cash value to pay any personal tax due upon the exit from the arrangement
The Plan: A NECA Split Dollar Arrangement
How it Works
- Split dollar is a term used to describe an arrangement in which a life insurance policy’s premium payments and benefits are split between two parties. In a split dollar arrangement, one party has a life insurance need and the second party has the funds to pay for the policy.
- Under a Non-Equity Collateral Assignment (NECA) split dollar arrangement used in this case, the business pays the annual premium for a life insurance policy, which is owned by the business owner.
- The policy is pledged — via a collateral assignment — to the business as security for repayment. Under the terms of this agreement, the business is required to be repaid the GREATER of the premiums paid or the cash value.
- The death benefit in excess of the repayment amount is paid to the policy beneficiary.
- In this case, the business will also pay any income tax charged to the business owner on the "economic benefit" costs associated with the trust's share of the death benefit via an additional cash bonus. (Fundamentally, a NECA arrangement works very much like a conventional loan but with economic benefit costs in lieu of loan interest.1)
- At retirement, the NECA agreement terminates, and the business decides to waive its right to repayment (aka releases the assignment). The business owner uses policy cash value to pay the tax on the forgiven debt.
Why it Works:
- Business owner secures his life insurance death benefit goal of $3M in all years using money from the business to pay the premium.
- The business owner’s tax on the economic benefit cost is lower than the tax on the annual premium.
- The policy cash value does not exceed the total premium paid while the agreement is in place.
- The life insurance policy can support a distribution from the policy cash value to pay the business owner’s tax due on the release of the collateral assignment.
When a business owner client has a life insurance need—or when they want to retain/reward a key employee — using corporate dollars through a NECA Split Dollar arrangement can provide a valuable benefit.
1. A NECA split dollar arrangement is governed by Treas. Reg. 1.61-22. Careful attention should be paid to these regulations as they include strict rules.