Planning For Retirement

Little known perk can build hundreds of thousands of tax free income!

Still considering retiring early? You'd do well to consider "split dollar" life insurance as a benefit. Consider: A 35 year old sales manager in a retail furniture store wants to stop working in 15 short years. He socks away the maximum $9,240 of pre-tax income in his 401K annually taking advantage of his employer's match - but it's hardly enough to retire on in style.

Because his boss doesn't want to lose him to the competition, he listens when he asks for a supplemental plan in the form of a split-dollar policy. By plunking down only $2,000 a year himself, the sales manager can expect to build up enough cash in the policy so that he'll end up with several hundred thousand dollars by the time he hits age 50.

Don't be surprised if you haven't heard about this perk. Until recently split-dollar life insurance, so called because the company and the employee share the cost of the premiums, has been reserved for a handful of key executives. Reebok's board has conferred a $50 million policy on Chairman Paul Fireman and his wife, for example. "Now, more firms are using the benefit below top-management ranks to reward highly valued workers and to keep them from going elsewhere," notes Stanfield Hill, of Mutual of New York. The monetary values of split-dollar insurance for the employee is very small in the early years and increases as the individual ages.

While the death benefits are generous, that's not the main attraction. Essentially, split-dollar life works as a supercharged retirement account without any cap on how much goes in yearly. The company pays the lion's share of the premiums - which might run $12,000 per million dollars of insurance for people in their early 30s. When the plan is terminated, the company gets its contributions back. Meanwhile, most of the premium grows tax-deferred in either a whole-life policy, which offers a bond-like rate of return, or in a variable life policy, where stocks often are the investment. Unlike cash buildup in a regular retirement plan, the buildup in a split-dollar policy can be tapped without penalty before age 59-1/2. Withdrawals can be structured as loans from the policy-which means no income taxes. Many executives use a policy to create wealth for their heirs; heads of family firms, to cover estate taxes on the business.

The results are nothing short of stunning. For example, take the case of a 44 year old executive who plans to retire in 20 years. He and his company split the cost of a $1.8 million whole-life policy purchased for an annual premium of $50,000. the employee initially puts up only $1,900 of that - the same as a simple term life insurance policy with an equal benefit would cost. The company pays the remaining $48,100.

At retirement (or your death when the split-dollar arrangement is terminated) the company gets back what it paid out. In this case, the death benefit after 20 years has grown to $3.2 million.; to free up the needed cash to repay the employer's contributions, the benefit is cut in half. The worker ends up with a policy worth $1.6 million; his contributions which rise slowly over the 20 years, only total about $75,000 and stop at termination. Under one withdrawal schedule, he could comfortably take out $65,000 a year for 17 years. The cash qualifies as a tax-free loan that is eventually repaid from the death benefit.

Finally, there's a question of whether split-dollar plans will be allowed forever. So far, the Internal Revenue Service has given them the nod - and the insurance industry has had an excellent record of defending its products in Congress. But the IRS is known to be reviewing several features. Among them: what are in effect tax-free investment loans from the employer, used to fund an employee benefit. If tax rules are changed, existing policies are likely to be protected through grandfathering. For now, split-dollar remains one of the least known and best ways to fund a retirement.