In August 2016, the University of Michigan began a trend by offering their football coach a split-dollar life insurance arrangement as an alternative to deferred compensation. Other football coaches in different schools have similar arrangements.
The overarching principles of these kinds of plans can apply to you as well without having to be rich or famous to take advantage of the benefits.
This is a program where the employer agrees to loan dollars to an employee, generally over a period of 7 years, that are invested in a cash accumulation life insurance policy. Unlike traditional life insurance policies where you want the highest death benefit at the lowest premium, these plans are the opposite.
The plan is attempting to mimic the best aspects of the Roth IRA without any of the limitations, and there are a number of limitations of a Roth IRA that would make them unattractive to people like Jim Harbaugh.
At some point, the loan will be repaid, but in the meantime policy cash flow in excess of the balance can be accessed tax-free to supplement cash flow in retirement.
It’s a win/win arrangement for both parties. For the employer, they incentivize the coach to stick around and for the employee, they get to take advantage of a tax-free accumulation tool that otherwise wouldn’t be available to them.
As good as the arrangement is, it can be improved upon. Interest-free is not cost-free. Every year Jim Harbaugh has to pay tax on imputed income. Since the money is broken out over 7 years, the interest rate ebbs and flows, and the cost to him is variable.
Jim Harbaugh won’t know the full extent of his imputed income until the final seventh installment has been made.
If they were to do this deal again, it would make more sense to make the loan all upfront and lock in the interest rate.
The key to this approach is having an accumulation tool that’s going to grow the money to the point where it far exceeds what the repayment of the loan has to be. Without that tool, you won’t have the ability to grow.
Rumour has it that the arrangement with Jim Harbaugh involved a whole life policy, but when they compared that to an indexed universal life policy it could have been even better.
This kind of arrangement has two key components: the money has to grow safely and productively (net of fees 5% to 7%), and you need to look at how you get the money out.
With whole life policies, we know they can have a net cost of borrowing. The problem comes when there is an arbitrage between the rate on your collateral account and the loan rate.
One of the most important provisions in the life insurance retirement plan contract is the loan provision because if you give them 30 years to make up their mind, it’s not always going to be in your favor.
At its core, the purpose of the program is to promote the long-term retention of the employee in a tax-efficient manner. It works best when the employee is able to receive the maximum benefit possible from the dollars provided in exchange for expressing a long-term commitment.
All of this reinforces the virtues of the life insurance retirement plan. Wealthy coaches have used this type of arrangement because they have attributes you can’t find in any other type of retirement plan.
There is no income limitation or contribution limits, and you can take the money out tax-free and potentially cost-free, and it comes with a death benefit.
Mentioned in this Episode:
Why College Coaches Are Being Paid With Split-Dollar Life Insurance – fa-mag.com/news/why-college-coaches-are-being-paid-with-split-dollar-life-insurance-56010.html?section=