Working on sales of survivorship life insurance involves many client variables. Often, helping clients select an attractive financing strategy for survivorship life insurance policies owned by an irrevocable life insurance trust is the key to closing the sale. If you target this type of sale, it’s important to familiarize yourself with these commonly-used financing strategies.
Annual exclusion gifts are generally the favorite financing strategy. This approach works best when the policy premium is less than the dollar amount of annual exclusion gifts available. Relative simplicity, ease of communication, certainty, and ease of termination (if necessary) are the primary benefits of this strategy.
Clients who hold income producing, highly-appreciable assets, and who have a substantial net worth, may consider gifts of such property to an ILIT. Gifts up to $2 million may be made to an ILIT ($1 million from each spouse) without paying any out-of-pocket gift tax. Earnings from these assets, generally reported as income by the grantors, are used to pay policy premiums.
Future appreciation of these gifted assets is excluded from the clients’ taxable estate at death. Additional gift tax leverage may be available through discounting of minority interests in privately-held companies. Many planners consider it advisable to pay premiums on a limited-pay basis to minimize future self-completion risks, such as a decrease in the assets’ earnings. It is also important to remember that once property is gifted to an ILIT, it can not be returned to the trust’s grantors.
Regrettably, some planners no longer include private split-dollar arrangements among the options for financing large survivorship policies owned by ILITs. This view overlooks the significant gift tax leverage in arrangements involving survivorship policies.
Instead of annual exclusion gifts being linked to policy premiums, annual exclusion gifts in a private split-dollar arrangement are based on the amount of economic benefit provided by the arrangement sponsors. Typically, cash gifts to the ILIT are used by the trustee to reimburse the sponsors for economic benefit costs provided by the split-dollar arrangement.
While both spouses are alive, the economic benefit is generally measured using cost of insurance rates derived from Table 2001. The calculation of this amount assumes that both spouses die in the same year. The amount of this economic benefit is often exceptionally low when compared with the full policy premium.
Many planners and advisors recommend using a limited-pay design with survivorship policy in split-dollar arrangements. This approach minimizes the risk that the economic benefit amount will sharply increase after one of the spouses dies. If the economic benefit increases, then annual exclusion gifts will also need to increase.
When private split-dollar arrangements are used, clients are underserved if a well-defined rollout strategy is not part of the plan design. One popular rollout strategy is for the sponsors to terminate the split-dollar arrangement and not require the ILIT to repay premium advances.