Insurance Curator High-net-worth (HNW) estate plans in the United States frequently use split-dollar life insurance to retain executive talent, fund buy-sell agreements, and move wealth into trusts with tax efficiency. But unwinding a split-dollar arrangement—whether at termination, sale, death, or corporate restructuring—creates significant tax and practical risks. This guide (focused on U.S. taxpayers, with practical notes for advisors in New York City, Miami, Los Angeles, and San Francisco) explains the major traps, the transfer‑for‑value problem, and how to manage post‑termination exposures.
Quick primer: why unwinds matter
Split-dollar arrangements are typically structured under either the loan regime or the economic benefit regime. Each has different tax mechanics and, crucially, different risks on termination. For a deeper technical explanation see Split-Dollar Insurance Demystified: Structures, Regimes, and Tax Consequences for Owners and a focused comparison at Economic Benefit vs Loan Regime: How the IRS Treats Split-Dollar Arrangements Today.
Key IRS guidance remains authoritative: see IRS Notice 2002‑8 on the split‑dollar transition rules and rules for determining taxable benefits. For basics on life insurance taxation and the statutory foundation for the transfer-for-value rule, see 26 U.S.C. § 101. (IRS Notice 2002‑8: https://www.irs.gov/pub/irs-drop/n-02-08.pdf; IRC §101: https://www.law.cornell.edu/uscode/text/26/101)
Major tax traps when unwinding split‑dollar
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Imputed compensation under economic benefit regime
When an employer provided coverage using the economic benefit approach, termination may trigger imputed wages or constructive receipt. The employee may face immediate income inclusion for the unreported taxable economic benefit accrued during coverage. -
Loan regime loan acceleration
In loan-regime arrangements, outstanding policy loans or intercompany loans may be treated as currently taxable if the lender accelerates repayment or forgives indebtedness. Unpaid interest can also create taxable imputed interest that compounds exposure. -
Transfer‑for‑value rule
If the policy is transferred for valuable consideration (including buyouts), IRC rules can cause the death benefit to be taxable (in whole or in part) to the beneficiary. Transfers to certain parties (the insured, a partnership in which the insured is a partner, a corporation in which the insured is a shareholder or officer, or individuals that qualify under statutory exceptions) may avoid the rule—so structuring the recipient matters. -
ERISA and employer-owned policy compliance
Termination actions that don’t respect ERISA or state employer‑policy rules can trigger plan liabilities or even remedial taxes.
Transfer‑for‑value: the core mechanics and a numeric example
The transfer‑for‑value rule can change life insurance proceeds from tax-free to partially or fully taxable. The rule applies when a policy is sold or transferred for consideration. Exceptions exist (notably transfers to the insured, partnerships or corporations with specified relationships, or certain stock transfers), but reliance on exceptions requires strict facts and careful drafting.
Example (illustrative):
- Death benefit: $5,000,000
- Policy basis/cash value (owner’s basis): $400,000
- If the policy is transferred for value (no exception), the beneficiary’s tax-free treatment may be disallowed and the taxable portion can be substantial—potentially millions—depending on the transferee’s basis and subsequent premium payments.
Precise tax outcomes depend on basis, cash surrender value, and whether the transfer meets an exception. Consult IRC §101 and IRS guidance before any buyout or assignment.
Post‑termination practical risks (and how they bite)
- Outstanding policy loans or intercompany advances may be treated as taxable compensation if forgiven or modified.
- Employer buyouts of employee rights can be classified as taxable wages rather than a tax‑free transfer, especially where consideration is disproportionate.
- Collateral assignments that convert to outright transfers risk invoking the transfer-for-value rule.
- State‑level rules (e.g., New York’s strict insurance and premium tax regime) and community‑property issues in California can affect spousal claims and estate inclusion.
For employer-specific compliance and ERISA pitfalls, review Employer-Owned Policies and Split-Dollar: Compliance, ERISA Issues, and Best Practices.
Comparison: Common unwind risks and mitigations
| Risk | Typical tax consequence | Practical mitigation | Pros / Cons |
|---|---|---|---|
| Economic benefit imputed income on termination | Immediate wage income to employee | Convert to loan regime; formal repayment schedule; indemnity escrows | + Reduces immediate wage; − Must service loan interest |
| Transfer‑for‑value on buyout | Death proceeds partially/fully taxable | Structure buyout to meet statutory exception; use third‑party trust purchaser | + Avoids taxable proceeds; − Requires careful entity selection |
| Forgiven intercompany loan | Taxable cancellation of indebtedness | Repay from escrow/cash value; negotiate formal sale price equal to basis | + Avoid COD income; − Liquidity required |
| ERISA violation on employer action | Plan liability, excise taxes | ERISA counsel review; follow plan documents and SPD | + Compliance; − Process can be time-consuming |
Pricing realities and providers (U.S. market)
Advisors handling HNW splits must coordinate with insurers, PPLI managers, and valuation specialists. Providers and typical commercial benchmarks:
- Private Placement Life Insurance (PPLI): Minimums commonly range from $1 million to $5 million in premium or invested assets; providers include Lombard International, Allianz, and Swiss Re Life Solutions. Lombard International and other PPLI providers commonly set minimum initial investments in the $2M–$5M range for U.S. client programs.
- Large-cap insurers for jumbo policies: Companies like Northwestern Mutual, MassMutual, Prudential, Lincoln Financial, and John Hancock underwrite jumbo or high‑face policies. Minimum face amounts for custom underwriting often begin at $1,000,000, with competitive pricing dependent on insured age, underwriting class, and product (term vs. UL vs. whole life).
- Buyout pricing: Employer buyouts or policy purchases often start at cash surrender value plus a negotiated premium; in practice, buyouts for corporate‑owned policies often fall in the range of cash value + 5%–15% depending on negotiation and projected mortality/expense charges.
Because pricing and minima change and underwriting is individualized, advisors in New York City, Miami, Los Angeles, and San Francisco should obtain competing formal illustrations from carriers and PPLI managers before settling on a wind‑down route.
Checklist for HNW families and advisors before unwinding
- Confirm the split‑dollar regime in effect (loan vs economic benefit).
- Obtain contemporaneous policy valuations and the insurer’s cash surrender/buyout quote.
- Determine outstanding loan balances and whether they accelerate on termination.
- Confirm whether a proposed transfer triggers the transfer‑for‑value rule and whether an exception applies.
- Evaluate ERISA status and plan documents if employer‑involved. See also Drafting Split-Dollar Agreements: Protecting Interests, Valuation, and Repayment Terms for contractual protections.
- Coordinate with PPLI managers or life carriers (get at least 2 quotes for large policies).
- Document the unwind with written agreements, escrow instructions, and tax counsel sign‑off.
Final notes
Unwinding split‑dollar arrangements is a cross‑disciplinary exercise: tax law (including the transfer‑for‑value rule and IRS guidance such as Notice 2002‑8), contract law, ERISA, and insurance underwriting all intersect. Engage experienced tax counsel, ERISA advisors, and actuaries before executing terminations or buyouts. For implementation scenarios where split‑dollar is used to reward executives or preserve family wealth, see practical case-driven guidance at Using Split-Dollar to Reward Key Executives and Preserve Family Wealth in Closely Held Firms.
Selected references
- IRS Notice 2002‑8 (split‑dollar guidance): https://www.irs.gov/pub/irs-drop/n-02-08.pdf
- 26 U.S.C. §101 — Life insurance proceeds (transfer‑for‑value rule foundation): https://www.law.cornell.edu/uscode/text/26/101