lFinancial professionals should first have a basic familiarity with the Tax Cuts and Jobs Act (TCJA) to evaluate the potential strength of a split-dollar strategy. It is important to know that many clients may have more cash for family protection and retirement planning because of tax reduction. When working with businesses it can be even more important. Many businesses that could not afford executive benefits in the past are now able to afford them.
Tax Benefits for Corporations
Corporations benefit from a 14% reduction in tax rates and pass through entities receive a 20% deduction on certain types of income. This new tax dynamic favors different executive benefit solutions. When corporate tax rates were at 35% solutions like under Sec. 162, executive bonuses were very attractive because the premiums were a bonus to the executive as income and they were deductible on the corporate level. The employee had to pay tax on the income, however sometimes the executive’s individual bracket was lower. The weakest aspect of these arrangements was a lack of true golden handcuffs. Even with a Restrictive Endorsement Bonus Agreement (REBA) or policy restriction in place, there was no true vesting and no ability for the corporation to recoup cost if the executive left.
Where do Split-Dollar Alternatives Fit?
With the TCJA in place, even when there is no corporate deduction, benefits are paid for with 79 cents left out of every dollar rather than the 65 cents when tax rates were higher. When gauging the overall tax impact to the corporation and the employee a new winner emerges, the split-dollar strategy is still alive! In addition to the substantial tax benefits, split-dollar strategies can provide a much stronger hold on the executive and insure that the corporation will recoup its total cost if the executive dies or leaves.
Executive Bonus vs. Split-Dollar
Here's a simplified hypothetical example. Compare the results of a traditional executive bonus arrangement versus a split-dollar strategy. This example uses a male executive at age 45 with a combined 35% state and federal tax bracket and a 21% corporate tax rate. The income used for the split-dollar strategy is provided by using Prudential one year term rates.
Executive Bonus
|
Employer Contribution |
Employer Tax |
Employee Income |
Employee Tax |
Employer Recovery |
|
50000 |
0 |
50000 |
17500 |
0 |
Split-Dollar
|
Employer Contribution |
Employer Tax |
Employee Income |
Employee Tax |
Employer Recovery |
|
50000 |
10500 |
2385 |
834 |
50000 |
As you can see, the total tax bite under an executive bonus strategy is $17,500 compared to the total tax impact for the split-dollar strategy of $11,334. Another benefit of the split-dollar alternative is that the corporation recovers 100% of the cost of this bonus program if the executive dies or leaves to work for a competitor. This results in a higher level of corporate protection than is available in a traditional executive bonus plan.
Different Designs for Different Clients
This example is of the most straightforward type of split-dollar, the endorsement method where the employer owns the policy. Depending on business and executive needs, there may be many other designs available. The collateral assignment allows the executive to own the policy. Loan-based split-dollar strategies can leverage retirement income by introducing premium financing into the mix. Split-dollar offers a flexible platform for achieving executive compensation goals in an environment where key employee retention is a real challenge.
Opportunity for Financial Professionals
This is one example of a refreshed strategy that produces a more favorable tax result under the TCJA. Whenever there is a tax change, particularly the largest one in 30 years, there are new challenges and opportunities. Businesses have more money to spend on benefits and have a better shot at retaining top talent in a fluid job marketplace. It is imperative that you open the door with business owners to capitalize on these new opportunities.
