Saving at mach speed; split-dollar life insurance works like a super-duper IRA
Still holding out hope of retiring by age 50? You’d do well to work for a company that offers “split dollar” life insurance as a benefit. Consider: A 35-year-old ace software programmer wants to stop working in 15 short years. She socks away the maximum $9,240 of pre-tax income in her 401(k) annually–taking full advantage of her employer’s match–but it’s hardly enough to retire on in style.
Because her boss doesn’t want to lose her to the competition, he listens when she asks for a supplemental retirement plan in the form of a split-dollar policy. By plunking down only $2,000 a year herself, the programmer can expect to build up enough cash in the policy so that she’ll end up with several hundred thousand dollars by the time she hits age 50.
You’re not a rarity if you haven’t heard about this perk. Until recently split-dollar life insurance, so called because the company and the employee share the cost of the premiums, has been reserved for a handful of key executives. Reebok’s board has conferred a $50 million policy on Chairman Paul Fireman and his wife, for example. “Now, more firms are using the benefit below top-management ranks to reward highly valued workers and to keep them from going elsewhere,” notes Stanfield Hill, of Mutual of New York. The monetary value of split-dollar insurance for the employee is very small in the early years and increases as the individual ages.
While the death benefits are generous, that’s not the main attraction. Essentially, split-dollar life works as a supercharged retirement account without any cap on how much goes in yearly. The company pays the lion’s share of the premiums–which might run $30,000 per million dollars of insurance for people in their early 30s–and gets its contributions back when the plan is terminated. Meanwhile, most of the premium grows tax-deferred in either a whole-life policy, which offers a bondlike rate of return, or in a variable life policy, where stocks often are the investment. Unlike cash buildup in a regular retirement plan, the buildup in a split-dollar policy can be tapped without penalty before age 59 1/2. Withdrawals can be structured as loans from the policy–which means no income taxes. Many executives use a policy to create wealth for their heirs; heads of family firms, to cover estate taxes on the business.
The mechanism is nothing short of stunning. New York insurance expert Lee Slavutin illustrates with the case of an employee who is 44 and plans to retire in 20 years. He and his company split the cost of a $1.8 million whole-life policy, purchased for an annual premium of $50,000. The employee initially puts up only $1,900 of that–the same as a simple, term life-insurance policy with an equal benefit would cost. The company pays the remaining $48,100.
At retirement (or your death or leave-taking, when the split-dollar arrangement is terminated), the company gets back what it paid out. In this case, the death benefit after 20 years has grown to $3.2 million; to free up the needed cash to repay the employer’s contributions, the benefit is cut in half. The worker ends up with a policy worth $1.6 million; his contributions, which rise slowly over the 20 years, only total about $75,000 and stop at termination. Under one withdrawal schedule, he could comfortably take out $65,000 a year for 17 years. The cash qualifies as a tax-free loan that is eventually repaid from the death benefit.
As with any product that appears too good to be true, it is necessary to consider what appearances rest on. Insurance-company projections of how much you’ll end up with are not guaranteed; the reality will depend on investment performance. Slavutin’s example factored in a return of 9.3 percent a year. Were that return to fall to 7.5 percent, annual withdrawals would be significantly less than $65,000. Someone choosing a variable life policy would have to beware of projections that assume a 12 percent annual return–the highest rate regulators permit to be illustrated. That’s higher than the 10 percent long-term rate of return of the Standard & Poor’s 500.
Finally, there’s a question of whether split-dollar plans will be allowed forever. So far, the Internal Revenue Service has given them the nod–and the insurance industry has had an excellent record of defending its products in Congress. But the IRS is known to be reviewing several features. Among them: what are in effect tax-free investment loans from the employer, used to fund an employee benefit. If tax rules are changed, existing policies are likely to be protected through grandfathering. For now, split dollar remains one of the least known and best ways to fund a retirement–for the fortunate few who have access.
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