We have written frequently throughout the years of the estate tax advantages of ownership of life insurance through an irrevocable life insurance trust (an "ILIT"). For clients with taxable estates, the creation of a life insurance trust and the purchase of life insurance by the ILIT trustee is an exceptional strategy to replace the client’s assets that are spent to pay estate taxes.
Private split dollar insurance is an arrangement between two parties to share the cost of a life insurance policy and to share the life insurance proceeds upon the death of the insured. Split dollar arrangements have been used for many years to provide additional benefits to business executives, but based on Internal Revenue Service ("IRS") Private Letter Rulings issued over the years, lawyers and life insurance professionals have been advising their clients that these arrangements may, under the right circumstances, also be appropriate in a private context, i.e., outside an employment arrangement.
A private split dollar arrangement in an estate plan would be structured much like this: Husband creates an ILIT. The trustee of the ILIT and Wife enter into a split dollar contract whereby they agree that the trustee of the ILIT will purchase and own a life insurance policy on the life of Husband, the trustee will pay that portion of the life insurance premium equal to the "term" insurance cost and Wife will pay the balance of the premium. The Husband will make gifts to the ILIT that will permit the trustee to pay the premiums. Upon the death of Husband, Wife will be paid the greater of the cash value of the policy or the total amount of the insurance premiums Wife paid. To secure the ILIT’s obligation to Wife, the ILIT would execute a collateral assignment of the insurance proceeds, which (assignment) is registered with the insurance company.
In order for the Husband’s gift to the ILIT to be a " present gift" and thus within the annual gift tax exclusion of $13,000 (in 2009) and without being subtracted from his lifetime gift tax exclusion of $1,000,000, Husband must give the beneficiaries of the ILIT an immediate right to the gift. Husband does so by giving the beneficiaries what is called a "Crummey Letter," a right to the beneficiaries to withdraw the amount of the gift for a certain period of time. When the beneficiaries fail to exercise their right, the trustee can pay the premiums with the amount gifted, the annual gift tax exclusion is satisfied, and the lifetime gift tax exclusion is preserved.
Early IRS private letter rulings about private split dollar arrangements stated no gift was made to the ILIT by Wife when she paid her part of the insurance premium because she received an interest in the cash value of the policy for her payment. The rulings concluded that the life insurance proceeds would not be included in Husband’s estate for estate tax purposes because Husband did not retain any incidents of ownership in the policy owned by the ILIT.
A 1997 IRS ruling and a recent 2009 ruling considered a similar arrangement, but one in which the ILIT purchased second-to-die life insurance, and reached the same conclusion. Private letter rulings are not binding on the IRS, but they do provide guidance to estate planning practitioners of the IRS’s position on the subject.
Facially, one of the few disadvantages of an ILIT is that after a few years, presumably, the life insurance policy owned by the ILIT will have built up cash value that is not accessible by the creator of the ILIT. Properly structured, however, the ILIT can loan the cash value to the Wife or other members of the creator’s family.
The private split dollar arrangement is a valuable estate planning strategy for taxable estates. If you have any questions about the use of a private split dollar arrangement in your estate plan, please do not hesitate to telephone us. * * * * *