Endorsement Split-Dollar

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1 Endorsement Split-Dollar Allowing an Executive to Share in the Benefits of an Employer-Owned Life Insurance Policy AD-OC-859A

2 Endorsement Split-Dollar Searching for Executive Benefit Solutions Retaining key people is a top priority for most employers in today s competitive business environment. Employers look to executive benefits as a means to retain key executives. Many top executives need more life insurance protection both before and after retirement. Endorsement Split-Dollar is a strategy that may meet both the employer s and the executive s needs. 1 Providing Executives with Supplemental Life Insurance Protection The employer purchases a life insurance policy insuring the executive. Prior to issuance of the life insurance policy, the employer must provide written notice to the executive that it intends to be the owner and beneficiary of a life insurance policy on the executive s life and may choose to continue the coverage beyond the executive s employment. The employer must also notify the executive as to the maximum amount of life insurance that could be placed on the executive s life. The executive must give written consent to such life insurance coverage. 2 As a policyowner, the employer has the right to exercise all policy rights and nonforfeiture privileges, including the right to borrow or withdraw against the policy s cash value and the employer retains the right to change the beneficiary for its portion of the death benefit. Through an agreement, the employer endorses, or grants to the executive, the right to designate the beneficiary of part of or the entire death benefit in excess of the cash value. There are generally two premium options with an Endorsement Split-Dollar arrangement: 1. The executive will pay premiums equal to the Reportable Economic Benefit (REB) on his or her portion of the death benefit and the employer will pay the remainder of the premiums The employer will pay all premiums due. The executive will pay no premiums but the REB on his or her portion of the death benefit will be taxable to the executive. In the future, the employer may wish to terminate the Endorsement Split-Dollar arrangement. One termination option is to simply remove the endorsement on the policy such that the executive s interest in the policy s death benefit reverts to the employer. The employer may continue the life insurance policy or may surrender it for its cash surrender value. Alternatively, the employer may choose to bonus the life insurance policy to the executive. 4 In this bonus rollout option, the executive would pay tax on the fair market value of the life insurance policy and the employer may receive an income tax deduction. 5 Following a bonus rollout, the executive will be required to pay any future premium payments due. The executive, however, will no longer need to pay the REB amounts. 1 Endorsement Split-Dollar arrangements may be affected by the Sarbanes-Oxley Act of 2002 which prohibits personal loans by public companies to their directors and executive officers. Please contact your tax and legal advisor for further guidance. 2 Under IRC Sec. 101(j), the employer s portion of the life insurance policy s death benefit will be taxable in excess of the employer s basis in the life insurance policy unless an exception to IRC Sec. 101(j) is met. To meet one of these exceptions, the Executive should be a 5% or more shareholder, a director of the Employer, or a highly compensated employee as defined in either IRC Sec. 416(q) or IRC Sec. 105(h)(5). 3 Final Split-Dollar Regulations (Treas. Reg. Sec (d)(3)(ii)) reserved the issue of the cost of current life insurance protection for future guidance. Until such guidance is issued, Notice states that taxpayers may continue to use the insurance carrier s published one year term rates or the Table 2001 rates for arrangements entered into prior to January 28, For arrangements entered into after that date, taxpayers are generally limited to the Table 2001 rates. 4 Taxpayers should consult their tax advisor to determine if an optional bonus rollout would constitute deferred compensation and possibly require compliance with IRC Sec. 409A. 5 The deductability of the bonus is subject to the reasonable compensation limits established by IRC Sec. 162(a). 6 Nonqualified deferred compensation plans must comply with the rules and regulations under IRC Sec. 409A. 7 For federal income tax purposes, life insurance death benefits generally pay income tax-free to beneficiaries pursuant to IRC Sec. 101(a)(1). In certain situations, however, life insurance death benefits may be partially or wholly taxable. Situations include, but are not limited to: the transfer of a life insurance policy for valuable consideration unless the transfer qualifies for an exception under IRC Sec. 101(a)(2) (i.e. the transfer-for-value rule ); arrangements that lack an insurable interest based on state law; and an employer-owned policy unless the policy qualifies for an exception under IRC Sec. 101(j). Investment and Insurance Products: Not a Deposit Not FDIC Insured Not Insured by any Federal Government Agency No Bank Guarantee May Lose Value

3 Executive/Insured 1 Agreement Employer 2 Reportable Economic Benefit (REB) 4 Employer s Death Benefit Portion 3 Premiums 5 Executive s Death Benefit Portion Heirs Life Insurance Policy 1 Agreement: The employer enters into an agreement with the executive to make the premium payments for a life insurance policy insuring the executive. The employer retains an interest in the policy equal to at least the cash value. All or part of the death benefit in excess of the cash value is endorsed to the executive. 2 Reportable Economic Benefit (REB): In order to preserve the income tax-free nature of the policy s death benefit, the executive must either pay premiums equal to the REB on the executive s portion of the death benefit or pay the income taxes on the REB. 7 3 Premiums: The employer owns the life insurance policy and pays all or part of the premiums, insuring the executive. Please note that the employer must meet the notice and consent requirements of IRC Section 101(j) prior to the issuance of the policy for the employer s portion of the policy s death benefit to be income tax-free. 4 Employer s Death Benefit Portion: In the event of the executive s death, the employer will receive the death benefit at least equal to the cash value. 5 Executive s Death Benefit Portion: In the event of the executive s death, his or her heirs receive the executive s portion of the death benefit federal income tax-free. This material is not intended to be used, nor can it be used by any taxpayer, for the purpose of avoiding U.S. federal, state or local tax penalties. This material is written to support the promotion or marketing of the transaction(s) or matter(s) addressed by this material. Pacific Life, its distributors and their respective representatives do not provide tax, accounting or legal advice. Any taxpayer should seek advice based on the taxpayer s particular circumstances from an independent tax advisor.

4 Endorsement Split-Dollar Advantages for the Employer Include Additional executive benefits may increase loyalty and productivity. The employer retains full control over the policy, and has the right (subject to the terms of the agreement) to surrender the policy and access its cash value at any time and for any reason. The employer s cost may be recovered at the death of the executive. Advantages for the Executive Include Endorsement Split-Dollar can provide a key executive with current life insurance protection at a reasonable cost. Endorsement Split-Dollar is very flexible, and may offer the following options at the executive s retirement: 1. The employer can use the cash value to informally fund a nonqualified deferred compensation plan for the executive The employer can sell the policy (for its fair market value) to the executive. 3. Ownership of the entire life insurance policy (including the cash value) can be transferred to the executive in a taxable bonus rollout The employer may continue to own the life insurance policy to provide cost recovery. DisAdvantages for the Employer Include Premiums are not deductible to the employer. The payment of premiums by the executive equal to the REB is taxable to the employer. The amount of death benefit endorsed to the executive will pay to the executive s heirs at death, not to the employer. DisAdvantages for the Executive Include Payment of premiums by the executive, or taxation of premiums to the executive, equal to the REB does not give the executive cost basis in the policy. The REB cost may increase significantly as the executive nears retirement. The Power To Help You Succeed

5 Endorsement Split-Dollar This fact finder is provided to help you and your life insurance producer better understand your goals and objectives. Please return the information to your life insurance producer and not to Pacific Life as we cannot and do not provide financial, legal or tax advice. Vital Information Executive: Date of Birth: Risk Status: Insured: S NS Spouse: S NS Executive s Total Compensation: $ Federal Tax Bracket: % State Tax Bracket: % Retirement: Age Annual Income Goal: $ Officer of the Corporation? Yes No Shareholder of the Corporation? Yes No Percentage of Corporate Ownership: % Life Insurance Need: $ Employer Name: Employer Status: C-Corp S-Corp LLC Partnership Federal Tax Bracket: %_ State Tax Bracket: % Employer Annual Premium Commitment: $ Employer Life Insurance Need: $

6 Pacific Life Insurance Company Newport Beach, CA (800) Pacific Life & Annuity Company Newport Beach, CA (888) Pacific Life refers to Pacific Life Insurance Company and its affiliates, including Pacific Life & Annuity Company. Insurance products are issued by Pacific Life Insurance Company in all states except New York and in New York by Pacific Life & Annuity Company. Product availability and features may vary by state. Each insurance company is solely responsible for the financial obligations accruing under the products it issues. Insurance products and their guarantees, including optional benefits and any fixed subaccount crediting rates, are backed by the financial strength and claims-paying ability of the issuing insurance company, but they do not protect the value of the variable investment options. Look to the strength of the life insurance company with regard to such guarantees as these guarantees are not backed by the broker-dealer, insurance agency or their affiliates from which this product is purchased. Neither these entities nor their representatives make any representation or assurance regarding the claims-paying ability of the life insurance company. Variable insurance products are distributed by Pacific Select Distributors, Inc., (member FINRA & SIPC), a subsidiary of Pacific Life Insurance Company, and an affiliate of Pacific Life & Annuity Company, and are available through licensed third-party broker-dealers. Please Note: This brochure is designed to provide introductory information in regard to the subject matter covered. Neither Pacific Life nor its representatives offer legal or tax advice. Consult your attorney or tax advisor for complete up-to-date information concerning federal and state tax laws in this area. Life Insurance Producer s Name State Insurance License Number (or affix your business card) AD-OC-859A /12

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