Y—Private Split Dollar

Whereas a traditional split-dollar plan involves an employer and an employee, a private split-dollar plan is an agreement between individuals, or between an individual and a trust. A private split-dollar plan enables an insured tobothhave the policy cash values available for emergency and retirement purposes and exclude life insurance proceeds from his or her estate. For example, assume that a married couple wishes to establish a private split-dollar plan.

DURING LIFETIME. The individual who will become the insured (the “grantor”) establishes an irrevocable life insurance trust with the grantor's spouse and children as trust beneficiaries. The trustee then applies for life insurance on the grantor and enters into a collateral assignment split-dollar agreement with the spouse that provides for the sharing of premiums and death benefits between the spouse and the trust. Under the agreement, the spouse owns all cash values (although the policy is trust owned) and retains the sole right to borrow against or withdraw policy cash valves.

The trust’s share of the premium is equal to the “economic benefit” of the death benefit payable to the trust. To fund the trust’s portion of the premium, the insured makes annual gifts to the trust. These will qualify as “present interest” gifts provided the trust beneficiaries have Crummey withdrawal powers.

Alternatively, in a low-interest-rate environment, it may make more sense to establish the private split-dollar plan as a loan arrangement. In this way, the government’s monthly applicable federal rate (AFR) is used as the loan interest rate (cost of the loan) instead of the economic benefit (cost of insurance) that is based on the death benefit and the government’s Table 2001 cost of insurance rate table (or an insurer’s term rate table that qualifies under the rules).

The spouse pays the balance of the premium. These funds either come from the spouse’s separate property or are given by the grantor (insured) to his spouse free of any gift tax liability (i.e., the marital deduction enables married persons to pass unlimited amounts of property to each other during lifetime or upon death free of gift or estate taxes).

Prior to or during retirement the spouse can access policy cash values free of income taxes through withdrawals or loans against the policy. By this means the insured has indirect access to the cash values.

UPON DEATH. The death benefit payable to the spouse is the greater of the total premiums paid by the spouse or the policy cash values (less any outstanding loans). The trust receives the balance of the death benefit. Since the insured had no incidents of ownership in the policy, none of the death benefit is included in the insured's estate. Guided by the specific provisions of the trust, these estate tax-free proceeds are used to pay trust income and principal to the trust beneficiaries.