The Green Book released by Biden Administration late last month has an unpleasant surprise for wealthy Americans, provisions lurking halfway through a 114-page document released by the U.S. Treasury take aim at Dynasty trusts and Intentionally Defective Grantor trusts (IDGTs). These heavy tax law revisions will make utilizing life insurance as an asset class, most notably Private Split Dollar survivorship, even more valuable to help mitigate potentially massive estate and income taxes.
Private Split Dollar
Overview:
Split dollar life insurance is not a type of insurance, but an innovative method for dividing the premiums, ownership interests, and benefits of a permanent life insurance policy between two parties. Use of Private Split Dollar to fund life insurance can provide a great alternative to create a significant asset outside your taxable estate with minimal gift and income tax friction. This is accomplished by combining a Private Split Dollar arrangement with a grantor retained annuity trust (GRAT) or installment note sale to an intentionally defective grantor trust (IDGT).
Split Dollar is all about leverage, high-net worth families can loan money without the need to pay gift taxes to create multi-million dollar tax-free Life Insurance asset pools outside their taxable estates and later be repaid for the premiums.
Problem:
You are financially successful and may be thinking about preserving your wealth for your family’s future. However, the federal government may take more than half of your wealth through the estate tax upon your death. Life insurance, as an estate liquidity tool, may be helpful in wealth transfer planning and can play an important role in creating large asset pools of your wealth across generations.
Solution:
By splitting your premium, death benefit and cash values between you and your trust through the use of a Private Split Dollar agreement, you may be able to avoid or at least minimize gift taxes and transfer more to your heirs. This allows high-net worth individuals to lend the annual premium to an ILIT instead of making a gift of the premium. Only the economic value of the death benefit is paid by the individual to the trust as a gift each year which may initially represent only a fraction of the premium. Therefore, the gift tax value of the arrangement can be quite low. A Private Split Dollar plan works very much like a personal loan, but with a much lower economic benefit cost instead of a loan interest component.
How It Works:
Your ILIT will own a life insurance policy on the joint lives of you and your spouse. Most policies are structured with guaranteed death benefits with premiums paid over 10, 15 or 20 years. You lend the premium to the trust annually and you also make a gift of the economic value of the death benefit annually to the trust. The economic value, the amount of the gift you are providing the trust annually, is measured using either a government or insurance company rate table that takes into account your attained age as well as the amount of death benefit on the policy.
At death, your estate will receive a portion of the life insurance proceeds equal to the greater of either the policy’s cash value or total premium paid. If the agreement is terminated during your lifetime, you will also receive the amount from the ILIT.
When a survivorship policy insuring both you and your spouse is used in a Private Split Dollar arrangement, the economic benefit costs can be extremely low since the actuarial value of the policy death benefit is based on the joint lives of you and your spouse. Therefore, the gift tax value is significantly discounted. When the split dollar arrangement is terminated, either at death or during your lifetime, the trust must repay the amount owed to you. Since the economic value of the death benefit will increase significantly as you get older, it is important to create a strategy for your trust to repay the loan of premiums to you. The leverage is created by repaying the loan up to 30 years into the future, then the trust can use the appreciated values of gifts or loans that you make over the years.
Benefits:
- A Tax Free Dynasty Trust Asset
- Families can create significant assets outside their taxable estate that are tax free, guaranteed, self completing with minimal use of life time or annual gift exemptions.
- Estate Liquidity
- You may be able to acquire more of the insurance you need for estate liquidity purposes using a Private Split Dollar plan since the gift tax value of the arrangement initially may be significantly lower than it would be if the arrangement was not in place.
- Reduced Gift Tax
- The government or the insurer’s rate tables are used to determine the gift value of the private split dollar arrangement instead of premium, you may incur little or no gift tax initially when annual exclusion gifts are considered.
- Leveraged Annual Exclusion Gifts
- The annual gifts you make to your ILIT are leveraged significantly when life insurance is used.
Considerations:
- Liquidity
- This plan requires liquidity since you will be providing a significant portion of the premium.
- Increasing Economic Benefit
- A clear exit strategy should be created at the onset with a limited premium period and repayment of the loan at a future date since the rate table costs, which increase with age, may have significant gift tax implications in later years.
- Estate Taxation of Premium Repayment
- The amount of the collateral assignment repaid at death is included in the taxable estate and may be subject to estate tax. This is eliminated when the loan is repaid in future years.
*M3 Family Office, and M3 Advisory Group do not provide tax or legal advice