Private Split Dollar: How Clients Can Take Advantage of Exemptions

In anticipation of possible tax legislation in 2021, many ultra-high net worth clients have taken advantage of the large amount of the exemption to transfer assets outside of their taxable estate. Despite this planning, many clients will still have a large estate tax liability that will need to be funded. Trust-owned life insurance is a useful planning solution that creates future cash flow outside of the client’s taxable estate to help fund this liability.

With the exemption rolled out and trusts funded, clients are turning their attention to strategies for leveraging these donations. Naturally, there is reluctance to liquidate recently gifted assets to fund insurance coverage. For clients looking for an alternative method of funding trust-owned life insurance, private dollar sharing can help achieve this while minimizing its short-term cash commitment.

Dollar splitting is an agreement that divides or shares the elements of a life insurance policy (cash value, premiums, and death benefit) between two parties. Dollar sharing can take many forms, but this article will focus on the economic benefits regime and assume that the settlor of the trust will be the insured.

Figure 1 provides a visual representation of a typical shared dollar arrangement.

Split Dollar is an interesting planning solution for several reasons:

Ability to fund a large death benefit with little or no gift tax. Suppose a healthy couple aged 55 and 54 want second-to-die coverage for $25 million with an annual premium of $250,000 payable for 20 years. The trust’s share of the premium is modest because survival insurance rates are based on Table 2001 joint mortality. With a shared dollar, the economic benefit — the trust’s share of the initial premium — is only $384.

Allows existing trust assets to be managed as intended. The grantor in a shared dollar arrangement funds the majority of the premium, allowing its advisors to continue to invest the assets of the trust as intended.

The Trust’s low annual cash requirement frees up the advisory team to make longer-term investments to grow the Trust’s assets. It may also result in a reduction in the settlor’s income tax bill in the form of forgone capital gains taxes.

Provides excellent leverage due to low annual economic benefit charges. Using the same example, assume the trust has an investment account of $3.3 million growing at 5.00% per year. If the trust liquidates $250,000 per year to fund the life insurance, at the end of the 20th year the investment account would be approximately $600,000.

According to the dollar split, this same trust should have over $9 million in the 20th year. This is a direct result of the fact that the trust contributes only the smallest burdens of economic benefits. For clients with little or no exemption remaining, their trust can guarantee a $25 million death benefit for less than $100,000 of the trust’s total cash flow for the first 20 years.

The importance of an exit strategy. The dollar split is temporary way of financing life insurance — we can’t emphasize this enough. As clients age and plans mature, certain variables will affect the economy of sharing the dollar.

The cost of economic benefits increases every year. If this expense exceeds the annual premium, the excess is considered a gift charged to the trust. Once the final premium is paid, future years’ economic benefit expense will generate an imputed gift.

With no exit strategy and no dollar split plan still in place, the donor in our example could expect an imputed donation of $20,500 at ages 75 and 74. This figure continues to swell over time.

Typically, in a private arrangement with shared dollar economic benefits, the settlor’s interest is the greater of the premiums paid or the cash value of the policy. Until a shared dollar plan is unwound, the settlor’s interest is returned to it. This claim is part of their taxable assets in the event of death with the transfer of guarantee still in place.

A well-designed shared dollar plan considers the eventual termination of the plan early on by ensuring that the trust has sufficient assets to eventually repay the settlor.

In the example we used, the total premiums paid after year 20 are $5 million (20 times $250,000). The trust’s share was $95,770 and the settlor advanced $4,904,230. Thus, the trust owes the settlor these cumulative advances of $4,904,230. No interest factor is applied; it is purely a refund of premium or cash value.

With so many moving parts, ongoing administration of a plan is essential to ensure the desired outcome is achieved. Therefore, it is essential to partner with a life insurance company that has both the experience and the infrastructure for ongoing service and administration.

Modification of economic benefit rates

If the dollar-sharing arrangement is still in place at the time of the first death, a decision is needed on how to administer the plan going forward. The choices are usually:

  • Maintain the economic benefit arrangement by using the operator’s alternative term tariffs or by using the tariffs in the 2001 table for an individual.
  • Convert an economic advantage into a loan arrangement (change dollars).
  • The trust reimburses the settlor for its advances and terminates the shared dollar arrangement.
  • The grantor uses the exemption to get out.

change dollars

When a private dollar economic benefit sharing arrangement is converted to a loan plan, the settlor’s interest becomes a loan to the trust at a current applicable federal rate, or AFR. When this conversion coincides with the end of the insurance funding period, it may fix the ongoing cost of the arrangement.

Gift tracking and ongoing management

Under a shared dollar loan arrangement, each premium paid is treated as a separate loan to the trust at the then-current AFR. It is essential that protocols are in place to monitor and manage a program like this to ensure it remains compliant.

As clients age, the economic benefit factors and corresponding premium splits change. Work with an insurance advisory firm that can clearly communicate premium splits, annual gifts, Crummey reviews, rollout amounts, etc. to a fiduciary. allows a client’s team to focus their resources elsewhere.

Finally, we cannot overlook the importance of reviewing the underlying life insurance policies to ensure that they are performing as intended.

Dollar splitting is an efficient way to fund trust-owned life insurance. Clients can leverage existing funded trusts or, with their team of advisors, thoughtfully implement other planning strategies to fund trusts to complement shared dollar planning.

By working with an insurance company familiar with this type of sophisticated planning, advisors can be more confident that the planning will achieve the desired outcome.

This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Joel Desjardins is a partner and director of enclosure design for the Coyle Company. He uses his technical expertise in life insurance to develop and model advanced planning strategies, helping clients and their advisors achieve the best possible results in their estate and wealth transfer planning.

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