In its most basic sense, a split dollar is an arrangement where the values of a life insurance policy - premiums, cash values, and death benefits - are split between two parties.  A corporate split dollar involves an agreement between an employer and an employee, whereas a private split dollar usually consists of an individual (grantor) and an Irrevocable Life Insurance Trust (ILIT).  The premiums paid on the life insurance policy held inside of the ILIT are often paid by the grantor.  

Private split dollar arrangements typically fall under two mutually exclusive tax regimes:

Economic benefit regime: This is usually structured as a non-equity collateral assignment, where the ILIT owns the policy and assigns an interest in the policy back to the donor equal to the greater of the premiums paid into the policy or its cash value in any given year.  In this type of arrangement, the ILIT pays only the term cost of the life insurance, based on the “economic benefit,” while the remaining portion of the premium is traditionally paid by the grantor/donor.

‍Loan regime: In this type of arrangement, the ILIT owns the life insurance policy, and the donor pays the premium in the form of a loan to the ILIT, which is responsible for the loan interest back to the donor each year. The loan can be structured as either a demand loan, which can be called at any time by the donor, or a term loan, which has a fixed number of years and is measured by the Applicable Federal Rate (AFR) at the time the loan is made.

Gift tax efficiency

There are annual and lifetime limitations on gifting amounts. As of writing, a person can gift $17,000 annually or $12.9 million over a lifetime gift tax-free. Large life insurance policies with significant premium amounts would usually constitute a sizable gift to the ILIT.  However, with a split dollar agreement, when a donor advances funds to the ILIT, the IRS considers this a loan rather than a gift.  Therefore, the gift is reduced from the premium to either the economic benefit or loan interest, depending on the arrangement. 

Keep in mind that certain tax provisions are due to sunset at the end of 2025, with the gift exemption essentially being cut nearly in half, adjusted for inflation.

How does intergenerational split dollar work?

Intergenerational split dollar is a strategy that facilitates the transfer of wealth usually between three generations, typically within a family setting. In this arrangement, the oldest generation (often grandparents called G1) collaborates with a younger generation (usually their children called G2) to fund a life insurance policy benefitting the youngest generation (usually grandchildren called G3). 

It does involve a complex legal agreement, but at a high level, G1 advances funds to the ILIT, which purchases a life insurance policy on G2. G1 takes back a note receivable consisting of the greater of the premiums paid or the policy's cash value.  After the passing of G2, G3 will receive the remaining proceeds after repayment of the note.

Limitations of intergenerational split dollar agreements

It's important to note that tax laws and regulations can be complex and subject to change. Anyone considering an intergenerational split dollar arrangement should consult with qualified tax professionals and financial advisors who are well-versed in estate planning and insurance-related tax implications.

Several high-profile court cases highlight the risks of split dollar agreements, including the Estate of Levine v. Comm'r of Internal Revenue, Morrissette v. Comm'r of Internal Revenue, and Cahill v. Comm’r of Internal Revenue. These three cases boil down to the IRS's issues with estate repayments. 

For example, in the Morrissette case, the court held that the split dollar arrangement lacked sufficient loan repayment and did not accurately reflect the true value of the transactions in the ILIT. The court determined that the policy's value should have been included in the decedent's gross estate for federal estate tax purposes. Ultimately, the estate had to pay a 40% tax penalty for a gross valuation misstatement. 

All of these cases underscored the importance of adhering to proper structuring of intergenerational split dollar arrangements to avoid adverse tax implications.

Ideal client profile

An ideal client profile for an intergenerational split dollar agreement would typically involve:

High-net-worth individuals: The G1 clients should have sufficient assets to contribute to the arrangement, whether through loans or gifts, without compromising their financial security or lifestyle. In addition, G2 needs to have adequate liquidity to justify the benefit outlined in the life insurance policy. 

The desire for life insurance: The client should recognize the value of life insurance coverage for their heirs and understand how the split dollar arrangement can help provide this coverage.

Multi-generational focus: An emphasis on intergenerational wealth transfer and a willingness to engage in a long-term financial strategy that benefits current and future generations.

Comfort with complexity: Intergenerational split dollar agreements can involve legal, financial, and tax complexities. The ideal client would be comfortable navigating and understanding these complexities with the assistance of professionals.

Strong family relationships: A commitment to open and transparent communication between family members to ensure everyone is on board with the arrangement and its long-term implications.

Ultimately, the ideal client for an intergenerational split dollar agreement would value the opportunity to create a lasting legacy while addressing their estate planning, life insurance, and wealth transfer needs through a sophisticated and well-executed financial strategy.