Pros & Cons: Is Split Dollar Life Insurance Right For Your Family?

A split dollar life insurance agreement is a new way to help families share the cost of a life insurance policy.

It has benefits for both the older generation and the younger generation.

A split dollar life insurance agreement is not a type of insurance policy. Essentially, it’s a regular life insurance policy set up so that parents and children can both contribute to the premiums.

Parents like it because it teaches their grown children about financial responsibility and retirement planning.

It can be a tough sell for the kids, however, who now have to contribute to a policy that might not be of their choosing.

The upside is that the death benefit they’ll eventually receive is 100% tax-free. For some families, this is the only kind of inheritance they can afford to provide for their kids.

Choosing this kind of policy requires open communication and a clear set of expectations for both parents and kids. If everyone’s on the same financial page, the family gets all the benefits of life insurance with shared cost responsibilities. But if they’re not on the same page, it can lead to missed payments and lapsed policies.

Here’s a quick rundown of the pros and cons to help your family decide if a split dollar policy is right for them:

Pros

• Parents can teach children the value of planning ahead, combined with financial responsibility.
• Parents get help paying for policies that can help provide an inheritance for their children.
• Split dollar arrangements can be made for different types of life insurance: term, whole, universal, etc.
• Families can pick the cost-sharing strategy that works best for them: split the premiums 50/50, parents pay all for a certain number of years and the kids pick up the cost after that, or parents pay on a sliding scale that decreases every year (100% first year, 98% second year, 96% third year, etc.).
• Families have flexibility in deciding who to insure. The parents might be more expensive to insure due to their age and any health conditions, but the death benefit will reach the children sooner. The children would be less expensive to insure, but the death benefit would then only benefit the deceased child’s surviving spouse and grandchildren, and it will likely be quite some time before the child passes away.
• As with virtually all life insurance policies, the death benefit is income tax-free.

Cons

• Parents may not have the money to keep contributing to a policy, depending on their health care or long-term care costs.
• Children may not have the money to keep contributing to a policy, especially if they’re just starting out, starting families of their own, or experience a job loss.
• If the policy lapses due to non-payment, there is no way to recoup the previous payments.
• Families need to have consistent, clear communication about who is responsible for making payments, how the balances are to be transferred between them, and what happens if one party can’t fulfill their commitment.

Split dollar insurance gives parents the chance to provide an inheritance for their kids when there might otherwise be little to pass on. Many parents feel it’s only fair that the kids help contribute to that inheritance, since they won’t pay any income taxes on the death benefit.

The arrangement works best for families that are clear about the responsibilities for payment. If you’re comfortable talking about money, it’s a great way to share costs across the generation gap.

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