• Private split dollar plans are a strategic method for transferring wealth between generations while minimizing estate taxes.
• The two types of private split dollar plans, non-equity collateral assignment and loan regime, can be customized to fit individual needs.
• Private split dollar plans can help to minimize estate taxes while ensuring that the grantor retains a degree of control over the assets.

A private split dollar arrangement enables an individual (or the individual’s business) to share the benefits of a life insurance policy with an irrevocable life insurance trust (ILIT). This arrangement functions similarly to a loan, where the grantor receives the right to be repaid in the future.  A formal agreement outlines the responsibilities and benefits of each party involved. 

Private split dollar arrangements can help to mitigate estate and gift taxes, and are often used in estate planning and wealth transfer scenarios. 

How private split dollar plans work

A private split dollar plan involves two essential components: the life insurance policy and the split dollar agreement. The life insurance policy is a permanent policy, such as whole life, universal life, indexed universal life or variable universal life. It typically builds cash value over time and provides a death benefit.

The split dollar agreement is a legal contract that outlines the terms and conditions of the arrangement, including the premium payment responsibilities, division of policy benefits and repayment provisions.

There are two main types of private split dollar arrangements: non-equity collateral assignment and loan regime.

Non-equity collateral assignment split dollar plan

In a non-equity collateral assignment arrangement, the grantor's Irrevocable Life Insurance Trust (ILIT) owns a policy on the grantor—or the joint lives of the grantor and their spouse. The grantor lends the premium to the trust, and gifts funds to the trust equal to the economic benefit associated with the death benefit held in trust. 

The economic benefit refers to the annual renewable term cost associated with the amount of death benefit in the trust. The actual economic benefit is calculated using standardized government rate tables (see IRS Table 2001) or life insurance carrier's alternative term rate tables, if available. 

Upon the policyholder’s death, the estate receives a portion of the life insurance proceeds equal to the greater of premiums paid into the policy or the policy’s cash value at that time. If the agreement is terminated during the policyholder’s lifetime, the grantor receives this amount. This arrangement works well in survivorship cases, as joint economic benefit rates are low. However, the economic benefit value increases with age, so it is necessary to establish an exit strategy when designing the plan.

Loan regime split dollar plan

In a private loan regime split dollar plan, the grantor's ILIT owns a policy on the grantor—or the joint lives of the grantor and his or her spouse. The grantor, or their business, lends the ongoing premium to the trust, and the ILIT is responsible for paying the ongoing loan interest due back to the grantor each year. The interest can be paid on an annual basis or accrued and rolled up into the outstanding loan. 

Loan interest is based on the published Applicable Federal Rate (AFR) at the time each loan is made. Upon the policyowner’s death, the estate receives a portion of the life insurance proceeds equal to the outstanding loan amount at the time plus any interest accrued. 

If the agreement is terminated during the policyowner’s lifetime, the grantor would receive this amount. This arrangement works well for older individuals (where economic benefit rates would otherwise be high in a non-equity collateral assignment arrangement), and in low-interest-rate environments.

Private switch dollar plans

A switch dollar plan enables the trust owner to “switch” a non-equity collateral assignment arrangement to a loan regime arrangement when certain triggering events occur. Triggers include:

• The economic benefit cost becoming prohibitive
• The death of one spouse in a survivorship scenario, where the economic benefit rate transfers from joint-life to single-life; or 
• When the life insurance policy cash value exceeds the cumulative premiums paid

The flexibility of a switch dollar plan allows policyholders and their advisors to employ the most advantageous financial strategy throughout the life of the arrangement.

Benefits of private split dollar 

Private split dollar arrangements offer several benefits in terms of taxes, overall control, and estate freeze. By using private split dollar, gift taxes can be minimized as the gift is reduced from the premium amount to either the economic benefit or loan interest, depending on the arrangement. This can eliminate or reduce gift tax paid and preserve the grantor's gifting capacity for other purposes.

In terms of control, lending money to the trust instead of making an outright gift allows the grantor to retain control, as the amount due back can be recalled at any time. This offers flexibility and security for the grantor.

Lastly, private split dollar arrangements provide an estate freeze benefit. Any growth inside the trust that exceeds the amount due back to the grantor is kept outside of the grantor's estate. This allows for efficient wealth transfer and estate planning, ensuring that assets are protected and passed down to beneficiaries as intended.

Product selection

Private split dollar plans typically utilize a permanent life insurance policy, whether it is whole life or universal life. It can be beneficial to utilize a policy that does build up a significant amount of cash value, particularly whole life, indexed universal life, or variable universal life, as the cash value can be used as a potential exit strategy. Policies that are focused on providing guarantees with little to no cash value accumulation, such as no-lapse guaranteed universal life, can still be utilized but don’t provide much in the way of flexibility as far as the exit strategy is concerned, outside of the policy’s death benefit.  

Case study

Bob and Jane, both age 60 and in good health, are married and have built up a significant amount of wealth. They currently have no life insurance coverage in place and are concerned about losing a large portion of their wealth to estate taxes when they pass. 

Their financial advisor determines that the couple is in need of approximately $10,000,000 of life insurance coverage. However, they have a very limited gifting capacity. Their advisor mentions the possibility of establishing a private split dollar arrangement to alleviate potential gift tax concerns. 

The premium for $10,000,000 of coverage is $284,588, paid for 10 years.* Without implementing a split dollar plan, the annual premium would be the required gift to the trust each year. 

Bob and Jane establish a non-equity collateral assignment arrangement. The premium is advanced to the trust each year and the necessary gift in Year 1, based on the joint economic benefit rate at their age, is just $434. 

The economic benefit rate does increase with age. By year 20, the gift to the trust is $24,842. However, when the economic benefit rate starts to get prohibitive, Bob and Jane can switch from a non-equity collateral assignment arrangement to a loan regime split dollar plan. Once switched, the gift to the trust would no longer be the economic benefit cost, but rather the loan interest on the outstanding note in the new arrangement. This can help to keep the gift to the trust to a minimum and preserve more of their gifting capacity. The split dollar arrangement could ultimately be repaid at death or during lifetime by using an alternate exit strategy.

Additional considerations

Administration and compliance

Private split dollar plans require diligent administration and compliance to ensure the smooth functioning of the arrangement. Proper documentation, such as a written split dollar agreement, outlines the responsibilities and rights of both parties, including premium payment responsibilities, death benefit allocation, cash value sharing and other relevant provisions. 

The plan’s performance must be monitored regularly  of the plan's performance, with adjustments to the premium sharing ratio made to maintain the desired benefits.

Exit Strategies and plan termination

A well-structured private split dollar plan should include provisions for exit strategies and plan termination. Various factors, such as changes in financial needs, tax laws, or the relationship between the parties, may necessitate the termination or modification of the plan. 

Potential exit strategies include:

• Converting to loan regime arrangement: While this will not provide an exit from a private split dollar plan altogether, it is an effective means of moving out of a non-equity collateral assignment arrangement and keeping the overall plan as efficient as possible until a future exit. The initial non-equity arrangement is paid off by way of a note, and the note is then serviced going forward subject to a loan regime arrangement. 
• Grantor Retained Annuity Trust (GRAT): A GRAT is an arrangement where the grantor transfers an asset to the trust in exchange for an annuity payment that will pay the grantor an income stream for a set number of years.  At the end of the GRAT term, the asset will ultimately pass to the remainder beneficiary (in this case, the ILIT). This allows the grantor to shift equity into the trust on a gift-tax efficient basis. 
• Present interest gifts: Annual gifts can be made to the trust, in excess of the economic benefit or loan interest.  This will establish a side fund that can accumulate and ultimately be used to repay all, or a portion, of the arrangement.
• Lifetime gifts: Assuming there is sufficient lifetime gifting capacity, a gift could be made to the trust at any time to terminate the arrangement.
• Life insurance policy cash value: If the policy being used in a loan regime arrangement builds up enough cash value, it can be used to repay the outstanding loan. Generally, this is not possible in a non-equity collateral assignment arrangement since the payback to the grantor is the greater of premiums paid or cash value, which would likely lapse the policy.  
• Life insurance death benefit: While it is possible to use the policy proceeds to pay off the arrangement at death, other alternative exit strategies should still be considered.  

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* Based on a male, age 60, preferred nonsmoker and female, age 60, preferred nonsmoker - John Hancock Protection SUL with premium paid for 10 years with a return-of-premium death benefit option.

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