January 27, 2009, 6:00 am

A Real Example of The Split Dollar Strategy

by: The Financial Blogger    Category: Insurance
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A few weeks ago, I brought the idea of withdrawing money from a corporation or a holding company without having to pay taxes through The Split Dollar Strategy. I actually lied about the whole thing… you will have to pay taxes…. About 3% in the example that I will show you 😀 hehehe! 3% of taxes compared to appreciatively 33 to 36% if it would have been a dividend income or 45% to 48% if it would have been an interest or business income. Not bad, huh?



So here’s the deal: You have a corporation paying a $5,000 yearly premium for critical illness insurance. For a young man of 37 years, it could roughly represent an insurance of 200K if he would get a critical illness during the process.

So the premiums include the following:

– A critical illness insurance of 200K payable upon diagnosis (23 listed illnesses such as heart attack, cancer, etc.)

– Premium reimbursement in the end of the policy owner upon death of the insured

– Premium reimbursement option in the end of a named beneficiary (the individual owning the company in this situation)

Every year, the individual will have to declare a taxable benefit of $297 for being the beneficiary of the insurance premium reimbursement (here’s come the split dollar strategy ;-0 ).

So 15 years from now, you are still not ill (let’s hope for it!) and you cancel your critical illness insurance.

You will receive a nice cheque from the insurance company of $75K (so 5K times 15 years) free of taxes! Really? Not really 😉 You actually paid a big $142 every year in taxable benefit provided by your company through the critical illness insurance. So total paid in taxed over 15 years is $2,138 ($142 X 15 years). 2K on 75K… 2.85% in taxes 😀

I actually run the numbers to see what would happen if you invest the 5K every year within the company on the stock market and pay yourself a dividend (taxed at 33% for this example) after 15 years.

Well, in order to receive $72,862 (75K – $2,138 in taxes) from your company at a 33% tax rate, you need to have $108,750 within your company. If you invest $5,000 over 15 years within your company at a after tax yield of 5%, you will get your 108K. However, in order to make 5% after tax, you need to make about 7.15% (let say that you are taxed at 30% within the company). So if you are 100% that you will make more than 7% in the next 15 years, you don’t need this strategy 😉

Personally, I would certainly consider putting a part of my company liquidity into it ;-). Then again, I do neither recommend nor selling the Split Dollar Strategy. I am not an insurance licensed representative and I am simply telling you that you might want to look at the Split Dollar Strategy closer with an expert and professional that knows your personal financial situation.

I hope you enjoyed the demonstration of the split dollar and please comment if you have any questions 😀

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Comments

As you indicated in your posts on this topic, the fundamental assumption of employing this strategy is that holdco has sufficient cash flow to fund the insurance now and in the future.

It is one of those strategies better suited for cash flow rich companies or with a lot of retained earnings in hand over the years.

by: The Financial Blogger | January 27th, 2009 (8:11 pm)

TMW,
you are 100% right. It is also good for an holding that has 50K and more in cash and you don’t know how to withdraw from it. I’d love to get those kind of problems 😉