– by Marc Schwartz
Last summer ESPN.com ran the headline: Michigan, Jim Harbaugh agree to increased compensation in form of life insurance loan. We suspect that most sports fans just shrugged and moved on to see how the Cubs were doing, but those of us in the life insurance business sat up and took notice. After all, we seldom get any press on the business page, let alone the sports page. And this was indeed big news about a big compensation boost, using a relatively little-known but powerful combination: Split Dollar and cash value life insurance.
ESPN’s article, though, did not use the words “split dollar” at all, and that was fine. Sometimes we get caught up in our own jargon and forget that people outside our industry – clients, CPAs, sports writers, for instance – only care about what the arrangement accomplishes. Not only did this new agreement make Harbaugh the highest-paid head coach in college football, it left some other notable coaches in the dust. (USA Today: NCAA Football Coaches’ Salaries) In this blog we’ll explain why both Michigan and coach Harbaugh found this unusual approach to be in their mutual best interest, regardless of what the plan is called.
At its simplest the arrangement looks like this: the university loans $2 million a year to the coach for seven years in the form of premiums paid for a life insurance policy on the coach’s life. The coach will pay no interest to the university, and will instead be required to pay tax on that unpaid interest as imputed income from the university. The rate used to calculate that imputed income is determined in the Internal Revenue Code and published monthly by the Treasury Department as the Applicable Federal Rate (AFR). In return, policy values secure the loan – both the cash values and the life insurance death benefit can be used to repay the loan, should the university and coach part ways, though there are additional strategies to exit the arrangement that might prove less painful. For the coach, you can see the advantage to this right away: life insurance payable to his spouse and children, cash value growing inside the policy tax-deferred, with the potential to use that cash value in the future (preferably after several national championships). All in return for the tax bill on the imputed income from foregone interest, based on what are currently very low interest rates (the February 2017 AFR for this kind of loan is a little over 1%).
So what’s in it for the university? First, the arrangement ties the coach to the school for several years in order for all of the numbers to work to the coach’s full advantage. The life insurance benefit is there from day one, but there is much more of a reward, in the form of potential equity available for tax-free policy loans when the coach retires, along with substantial long-term life insurance death benefits for the coach’s family. Take a look at the sample presentation we have put together for a similar plan using an Index UL product to get an idea of how attractive this can be over the coach’s lifetime, and how much of an incentive it can be to keep the coach close to home. Second, the university’s loans are secured. The values in the policy provide the university with some assurance that its investment may be recovered if things don’t work out as planned.
While it may be a surprise to find this kind of insurance-based solution headlining the sports page, such plans have broad application in executive compensation arrangements for all kinds of businesses. In fact, the more attractive it becomes to spend money at the corporate/business level (because of lower corporate tax brackets), the more effective such plans can be. So, the next time you are looking for a life insurance solution that can strengthen the executive-employer relationship and provide an incentive for a valued employee to stay on until retirement, remember the University of Michigan, coach Harbaugh – and Windsor.