Using the Power of a Split-Dollar Plan to Enhance Executive Compensation

 

Case Study:

Bill is an executive for ABC Pharmaceuticals.  This company has realized significant tax savings due to the Tax Cuts and Jobs Act, and the owner has been looking for ways to reward Bill for being a key player, while also incentivizing him to stay with the company.


The Plan: Split-Dollar Loan Arrangement with Accumulation IUL

How it Works

  • Bill purchases a John Hancock Accumulation IUL policy for ~$1.3M. The policy is funded via a $500k split dollar loan from ABC Pharmaceuticals. The loan contract is set-up with a term of 20 years and a fixed long-term AFR rate of 3%.
  • The annual premium of $77K per year will be paid for seven years using the Preliminary Funding Account (PFA). In addition, the PFA prevents the policy from becoming a MEC contract (thus preserving the tax-free distribution in the future).
  • During the term of the loan, Bill will pay loan interest of $15K/yr, which ABC will help cover via an additional bonus provided to Bill (i.e., “double bonus). ABC has provided a valuable benefit, and because Bill is required to repay the loan, he may be discouraged from leaving.
  • Bill can repay the loan to his employer using the policy’s cash value in year 20.
  • The policy can continue growing tax deferred and provide tax-deferred distributions, if desired.

Why it Works:

  • ABC Pharmaceuticals provides a valuable benefit for Bill, but at the same time the plan ties Bill to the company
  • Death benefit proceeds will be received income tax-free by Bill’s beneficiary
  • The life insurance policy is designed to offer tax-free distributions, which can be used to pay-off the loan and help supplement Bill’s retirement income.

The Result

The split-dollar plan was a win-win for ABC Pharmaceuticals — they were able to utilize excess cash flow to provide a valuable benefit to Bill in a way that provided an incentive for him to stay with the company for years to come.

 

What you need to know

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The insurance figures in the case study are from an illustration. Not all benefits and values are guaranteed. The assumptions on which the non-guaranteed elements are based are subject to change by the insurer. Actual results may be more or less favorable. Non-insurance figures are hypothetical and are intended for illustrative purposes only.

Loans and withdrawals will reduce the death benefit, cash surrender value, and may cause the policy to lapse. Lapse or surrender of a policy with a loan may cause the recognition of taxable income. Policies classified as modified endowment contracts may be subject to tax when a loan or withdrawal is made. A federal tax penalty of 10% may also apply if the loan or withdrawal is taken prior to age 59 1/2.

There is a minimum and maximum funding amount for the PFA as well as a minimum and maximum funding period. Interest earned in the PFA will be taxable. Partial withdrawals are not available from the PFA and if a full withdrawal is requested, the PFA will terminate, and an early termination fee will apply. Refer to the PFA Agreement for more information.

Life insurance death benefit proceeds are generally excludable from the beneficiary’s gross income for income tax purposes. There are few exceptions such as when a life insurance policy has been transferred for valuable consideration.

This material does not constitute tax, legal, investment or accounting advice and is not intended for use by a taxpayer for the purposes of avoiding any IRS penalty. Comments on taxation are based on tax law current as of the time we produced the material. All information and materials provided by John Hancock are to support the marketing and sale of our products and services, and are not intended to be impartial advice or recommendations. John Hancock and its representatives will receive compensation from such sales or services. Anyone interested in these transactions or topics may want to seek advice based on his or her particular circumstances from independent advisors.

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