When a story about life insurance is reported by media outlets such as ESPN, the financial services community sits up and takes notice. Add outspoken University of Michigan head football coach Jim Harbaugh to the equation, and you have the most talked-
about life insurance story in recent years. What’s it all about? Split-dollar.
The concept of split-dollar is simple — two parties by agreement share in the rights and obligations of a life insurance policy. In this case, the two parties are the employer, the University of Michigan (UM), and the employee, Harbaugh. In essence, the policy premiums, cash value and death benefit are shared or “split” between UM and Harbaugh.
Because UM is a public entity, the split-dollar agreement was released to the public. Here is a rundown of what the agreement provides.
Beginning in 2016, UM was scheduled to make six annual life insurance premium payments of $2 million. The death benefit is unknown, but based on Harbaugh’s age (52) and relative health, it is estimated to be as high as $75 million.
Harbaugh owns the policy subject to a collateral assignment in favor of UM. So, in essence, UM is providing Harbaugh with an interest-free loan of the life insurance premiums.
There are some tax considerations to this arrangement. Each year, Harbaugh must include imputed interest in his income. It is taxed like compensation. The amount is calculated by multiplying the cumulative premiums by the applicable federal interest rate (the short-term AFR).
Harbaugh would be able to obtain extra cash through this arrangement if he wants or needs it. The agreement grants Harbaugh access to the policy’s cash value as long as the policy’s cash value exceeds certain thresholds. This makes the UM plan somewhat unique because a typical split-dollar plan does not grant the employee access to the cash value while the split-dollar plan is in place.
If Harbaugh dies while the agreement is in force, UM receives its premiums through the death benefit split. Harbaugh’s beneficiary receives the remainder.
But what if he is no longer at UM? If Harbaugh quits, is fired or leaves, UM exercises the collateral assignment and receives its premiums back through the policy’s cash value. The assignment is then removed, and Harbaugh keeps the policy and any remaining cash value. This payback provision motivates Harbaugh to stay with UM.
After the six-year period, the agreement may end and UM will be reimbursed for its premiums paid (from the policy’s cash value). However, the plan may be amended. For example, if the relationship is going well, the parties could extend the agreement beyond six years. This is one of the flexible aspects of split-dollar, and something that makes it attractive to employers.
In the end, the only cost to UM is the opportunity cost on the premiums. Harbaugh’s cost is the annual income he must recognize for tax purposes, which is typically a small amount compared with the premiums. There also may be income tax consequences later when Harbaugh accesses cash value from the policy, depending on the nature and extent of the policy withdrawal.
The split-dollar plan has features that work in favor of both UM and Harbaugh. Harbaugh gets the life insurance protection he needs and the potential for cash value accumulation at an affordable cost, while UM has little or no risk in providing the funds to pay the premiums.
You may not have a major university or a Big Ten Conference football coach in your community, but you can use the same concept with business owners in your marketplace. Think of Harbaugh as the CEO of the football program. The split-dollar plan is one of his fringe benefits. Split-dollar is generally appropriate for executives, officers and managers.
Split-dollar can be established for a single participant, such as in the Harbaugh case, or for a group or class of employees. In a typical plan, management and officer-
level employees may be offered the ability to participate. Virtually all of them will opt in. Split-dollar can fit in with nearly any type of entity, from publicly traded corporations to closely held limited liability corporations and S corporations to nonprofit entities.
Split-dollar can be compared to a Section 162 executive bonus plan. Both types of plans are non-qualified. They do not have to be pre-approved by the IRS, and they generally fall outside the rules and restrictions of the Employee Retirement Income Security Act. In addition, with both plans, employers get to pick and choose who will participate.
However, under a Section 162 executive bonus, the employer’s cost recovery is limited to the income tax deduction it may receive for its premiums paid. Under split-dollar, the employer can be reimbursed for all premiums paid, and potentially reimbursed for the interest on the premiums if the employer so desires.
The Harbaugh split-dollar case should be a wakeup call for all life insurance advisors: Split-dollar is alive and well. If you are not familiar with the split-dollar concept, you may unwittingly be letting lucrative opportunities pass you by.
Author’s note: All is not perfect with the case. There are concerns in the underwriting community. They feel the risk of loss may be great because UM’s football team has been getting killed by Ohio State University in recent years.