Now Is A Great Time For Survivorship Private Split Dollar

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George W. Bush made tax reform a key component of his successful campaign for president. Tax reform, Bush told us, would spur the economy and prevent a painful slowdown. Not surprisingly, with America experiencing the first noticeable economic correction in recent memory, Bush and the Republican leadership successfully pushed a $1.35 billion tax-cut package through Congress.

What this bill will do for the economy is anybodys guess, but what it means for estate planning advisors and their clients is clear. For estate planning advisors and their clients, this bill means confusion.

The bill promises to repeal the estate tax–a development that has been touted as great news for Americas farmers and small-business owners. But, before wealthy Americans begin rejoicing over their liberation from “death taxes,” they need to read the fine print. Although the bill promises to repeal the estate tax, it is a fleeting promise.

Under this reform package, the estate tax would be repealed for just one year2010. For those individuals dying before 2010, the bill offers slightly lower rates and a slightly higher exemption from estate taxes. For those dying after 2011, the bill promises nothing. Like all provisions in the bill, the estate tax reform provisions become null and void on Dec. 31, 2010, unless reinstated by a future Congress and president.

The bills treatment of gift taxes is even more interesting. For decades, the estate and gift tax rates and exemptions have been identical–or unified. In fact, the term “unified credit” is in the vocabulary of everyone who advises clients on estate and gift tax matters. Well, the “unified credit” is no more. After 2003, the gift and estate tax exemptions will no longer be the same. Unlike the “death tax” that will be gradually phased out and repealed in 2010 (for one year), the gift tax exemption increases to $1 million in 2002 and stays at that amount indefinitely.

The point of this article is not really to debate the merits of the new estate and gift tax rules. While I have been reluctant to go on record as saying that I dont believe the legislation makes a great deal of sense, the reality is that estate planning professionals need to find ways to help their clients plan in the confusion of this new tax environment.

It is a reality for estate planning professionals and their clients that the amount that is exempt from gift taxes is scheduled to go to $1 million in 2002 and permanently stay at that amount. It is also important to remember that individuals continue to have a $10,000 (per year, per beneficiary) annual exclusion from gift taxes that they can use for estate planning.

With the revenue loss from total repeal estimated at more than $50 billion per year after 2010, many commentators feel that economics will prevent the eventual repeal of the estate tax. However, despite the uncertainty of future repeal, the reality for estate planning professionals and their clients is that this bill gradually increases the amount that is exempt from estate taxes and promises to repeal the estate tax in 2010.

So, what does the elimination of the “unified” transfer tax system mean for estate planning? One month after passage of this new tax bill, some estate planning trends have started to take shape.

Not surprisingly, wealthy individuals are continuing to look for ways to ensure that their estates are protected at death. And, they are also less willing to do estate planning that will trigger lifetime transfer taxes. After all, while most people doubt the one-year estate tax repeal will benefit them, they know that they will pay gift taxes if they exceed the $1 million exemption.

To avoid current gift taxes, private split dollar has emerged as one of the most popular estate planning techniques. And, for second-to-die policies, there has never been a better time for split dollar. Many people dont realize it, but the recently issued IRS guidance on split dollar (IRS Notice 2001-10) makes survivorship split dollar more cost-effective than ever before.

What is Survivorship Private Split Dollar?

Split-dollar life insurance is not a special type of life insurance contract. Instead, it is an agreement between two or more parties to share or “split” a life insurance policys death benefit, cash value, ownership rights (such as the right to designate the beneficiary), and premium payments. Private split dollar is a term used to describe a split-dollar agreement between individuals (or irrevocable trusts created by such individuals) who do not have an employer/employee relationship. Because most private split-dollar cases involve members of a single family, private split dollar is sometimes referred to as “Family Split Dollar.”

Private split dollar can be done with either a single life or a second-to-die (i.e., “survivorship”) policy. Earlier this year, IRS Notice 2001-10 addressed the taxation of split-dollar arrangements. Advisors and commentators have focused on some of the negative aspects of the notice that appear to make split dollar less attractive for single life applications. However, what seems to be missing in nearly all the commentary on Notice 2001-10 is the fact that it is seemingly better to do survivorship split dollar than ever before.

Survivorship private split dollar is usually an agreement between an irrevocable life insurance trust (ILIT) created by a husband and wife. The primary benefit of this arrangement is to leverage the amount of death benefit that can pass to the ILIT free of estate taxes. A secondary benefit of the arrangement includes the ability of the trustee to give the policy cash value to the husband and/or wife under very limited circumstances.

A brief explanation of how survivorship private split dollar works should help. An ILIT is ordinarily the owner of the survivorship life insurance policy. The ILIT and the insureds will split the right to receive the death benefit. The portion of the death benefit payable to the insureds may be limited to their premiums paid (i.e., “equity split dollar”) or may be equal to the entire cash value.

The ILIT receives that portion of the death benefit not paid to the insureds. The ILIT pays only that portion of the premium equal to the economic benefit of the ILITs share of the death benefit (i.e., the amount at risk), and the insureds pay the remainder.

For many years, the economic benefit in survivorship split-dollar arrangements, including survivorship private split dollar, was ordinarily measured by the IRS “Table 38″ rates while both spouses were living. In some instances, the economic benefit was measured by the insurance companys lowest-cost survivorship term insurance.

Because the economic benefit cost payable by the ILIT is usually significantly less than the total premium payable under a survivorship private split-dollar arrangement, the insureds gift to the ILIT will be much less than the entire premium amount. By reducing the amount of the gift to the ILIT through the use of survivorship private split dollar, the current gift tax liability can be reduced (often avoided) in situations where the annual premium would otherwise exceed the insureds available annual exclusions and unified credits.

The Impact of Notice 2001-10

As previously mentioned, the economic benefit cost to the ILIT (i.e., the cost of the “term” insurance element owned by the ILIT) has historically been measured by what is known as the “IRS Table 38 rates.” Table 38 is a hypothetical rate table derived from the single life rate table (Table 58) provided by the IRS in Rev. Rul. 64-328 for use in single life split-dollar arrangements.

In IRS Notice 2001-10, the IRS introduced a new single life rate table to replace Table 58. This new single life table contains significantly lower rates than those in Table 58. However, the new (lower) IRS rate table is of little real benefit for single life split-dollar arrangements since the economic benefit in single life split dollar is almost always measured by the insurance companys cost of annually renewable term insurance (as allowed in Rev. Rul. 66-110).

The reduction in single life rates has had a tremendous positive impact on the economic benefit measurement for survivorship split-dollar applications.

It is relatively easy to understand the benefit of this new rate table (2001-10) on survivorship split-dollar arrangements when you realize how Table 38 (survivorship) was initially created. In grossly simplified terms, the likelihood of two individuals dying in one year is determined by multiplying the likelihood of one individual dying during that year times the likelihood of the second individual dying in that same year. For example (and purely as an example since I am not an actuary!), if the chance of one 70-year-old dying within the year is 3%, the chance of two 70-year-olds dying within the same year would be less than 1% (3% times 3% is 0.9%).

So, since the new Table 2001-10 single life rates range from one-half to one-fourth the old Table 58 rates, you can imagine how much new Table 2001-10 rates generate less expensive survivorship rates. The chart on this page shows an example of how much less expensive the new survivorship rates are when compared to the Table 38 rates.

Although there is no formal authority specifically addressing private split dollar, it has become a popular planning technique as a result of two favorable Private Letter Rulings issued by the IRS. PLR 9636033 permitted the use of single life private split dollar between an insureds spouse and an ILIT created by the insured. PLR 9745019 permitted a survivorship private split-dollar agreement between spouses and an ILIT.

While there is no formal authority for private split dollar, it is simply a logical extension of employer/employee split-dollar arrangements that have been an accepted planning technique for more than three decades. The IRS’s current position on the use of split dollar (in an employer-employee situation) is based on a series of favorable Revenue Rulings beginning with Rev. Rul. 64-328. The most recent IRS announcement on split dollar was IRS Notice 2001-10.

Because of estate tax reform, wealthy individuals are looking for a way to do estate planning without incurring current gift tax liability. Fortunately for estate planners and their wealthy clients, survivorship private split dollar is one planning technique that allows individuals to do irrevocable estate planning without triggering current gift tax liability. And, in what can best be described as a fortuitous coincidence, survivorship private split dollar has became a better deal than ever before.

is senior counsel, director of advanced markets and small-business insurance, Manulife Financial, Boston. He can be reached via e-mail at Randy_Zipse@manulife.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 6, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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