Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards

Retirement Planning > Saving for Retirement

When Client Objectives Are At Cross-Purposes, Try Private Split-Dollar

Your article was successfully shared with the contacts you provided.

This is a short synopsis of a phone call I received from a producer: I’ve got a guy. He’s a doctor with a wife and two kids and he’s still relatively young: 45-years-old. He doesn’t have an estate tax problem–yet. He is making a lot of money. He wants to save for retirement and protect his savings from creditors that may arise from future malpractice lawsuits.

He also wants to make sure that if he dies, his wife will have enough money to live on. He knows he needs life insurance and heard he could use it to help save for retirement, too. But if his estate grows the way we think it might, we don’t want the insurance in his estate. If we put it into a trust, he can’t access the cash value.

According to the objectives defined, the client needs:

? Retirement income.

? Creditor protection for the retirement income.

? Survivor income/estate liquidity.

These objectives conflict with each other. What can we do?

Enter private split-dollar

The situation may sound similar to those of some of your clients, particularly if you service medical professional clientele. If you’ve read the title of this article, you know we recommended a private split-dollar plan as an alternative. Why?

Private split-dollar plans allow you accomplish these competing objectives. Although known best for the gift tax leverage they offer, private split-dollar plans can also be arranged to retain access to life insurance policy cash values for retirement income.

Here’s how it works: The client establishes an irrevocable life insurance trust (ILIT) that will own the policy. The trust is a “defective” grantor trust for income and estate tax purposes, where the client is both the grantor and the insured. With this type of trust, trust income is taxable to the grantor and any transactions between the grantor and the ILIT are ignored for income tax purposes. The insured’s spouse advances money to the ILIT for premium payments. The ILIT will owe the spouse either the amount he or she advances to it or the policy cash values.

The ILIT owns the policy to avoid inclusion in the client’s taxable estate and to keep it beyond the reach of the client’s creditors. Most states’ laws largely or even entirely protect life insurance from creditors, with the exception of the Internal Revenue Service, provided that the debtor does not own the insurance and that any transfers were not done to defraud creditors.

Also, life insurance policy cash values owned by ILITs typically can’t be accessed by anyone other than the trustee without subverting estate tax and creditor protection planning. In a private split-dollar plan, the trustee will use the policy values to repay the client’s spouse for the money advanced to the trust. The payments the spouse receives from the ILIT may be used to supplement the couple’s retirement income. (It helps to have a solid marriage; otherwise, the spouse may be the only one who gets to supplement his or her income.)

If the amount owed to the spouse under the arrangement is limited to the amount of money he or she advanced to the ILIT, the arrangement will be established as a “loan regime” private split-dollar plan and interest will be either accrued or paid annually. The interest is often accrued to maximize the amounts paid to the spouse. But if the time horizon for repayment is short (e.g., less than 15 years) or if the policy cash values otherwise won’t support the repayment obligation that results from accruing the interest, the ILIT can pay the spouse the annual interest due from cash gifts made by the client.

Generally, it is not recommended to use economic benefit regime-based split-dollar arrangements because the ILIT would owe the spouse the entire policy cash value, a debt that could only be satisfied at the death of the insured or upon total surrender of the policy.

If the spouse pre-deceases the insured, any amount still owed to him or her would be included in their estate. For the insured to be able to derive retirement income from the policy, the amount owed would have to be passed to the insured. While the policy cash values owned by the ILIT would continue to be beyond the reach of the insured’s creditors, the death benefit proceeds could be included in his or her estate. How to best deal with this situation if it arises depends on the client’s situation at that point in time.

At the client’s death, the death benefit is paid to the ILIT. The ILIT then repays any remaining money owed to the spouse and uses the remainder to provide the liquidity needed to settle the client’s estate and distribute wealth to beneficiaries.

Valuable benefits

In summary, private split-dollar plans are not just for gift tax leverage. They have the potential to provide clients with 3 additional valuable benefits: retirement income from policy values, survivor income/estate liquidity from policy death benefits, and creditor protection for the retirement “fund” (policy values) and the death benefit owned by an ILIT.

If you encounter situations like the one described at the beginning of this article, consider evaluating how well a private split-dollar plan might work.


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.