C3 Financial Partners

The Mechanics of Private Split Dollar

Life insurance held in an irrevocable life insurance trust (ILIT) is a cornerstone of a solid wealth transfer strategy.  The funds life insurance provides when an estate tax is due allows families to protect their legacies and sustain wealth across generations.  Increasingly, these families are turning to private split dollar arrangements to fund ILIT-owned life insurance.  This technique minimizes estate taxes, preserves gifting and estate tax exemptions, and efficiently passes wealth to future generations.

C3 Financial Partners has helped families and their advisors safeguard wealth through implementing these plans for over three decades.

What is Private Split Dollar?

Private split dollar is commonly employed in the estate planning context between family members, traditionally between an individual and a trust for the benefit of such individual’s heirs.  Under such arrangement, an individual donor generally funds insurance premiums on the life of the donor, or perhaps on the life of another family member. The policy is typically owned by an ILIT for the benefit of the donor’s children or other beneficiaries.   As security for the premium advances, a collateral assignment is placed on the policy, requiring payment of the greater of the policy’s cash value or premiums paid at death or prior termination.

The purpose of such arrangement is generally twofold.  First, life insurance death proceeds are generally removed from the taxable estate of the donor for federal (and possibly state) estate tax purposes. Second, the gift tax value of any premium payment is reduced significantly.

The advancement of premiums can be treated as either a receipt of an economic benefit or as a loan from the donor.

Economic Benefit Treatment of Private Split Dollar

Under an economic benefit treatment, each year the donor, who is usually the grantor of the ILIT, is considered to have made a gift to the ILIT equal to the “economic benefit” cost associated with the death benefit being provided to the ILIT.  Alternatively, the ILIT can pay the economic benefit cost to the grantor to avoid a gift if the ILIT has cash available to do so.   The economic benefit associated with the death benefit is the cost of term insurance and determined by using premium rates published by the IRS in Table 2001 or, if lower, the qualifying one-year term rates published by the issuing insurer.

Because the economic benefit cost is the annual renewable term cost on the life of the insured, that cost increases incrementally each year as the insured gets older, unlike a fixed interest rate.  Economic benefit costs are usually quite modest for second-to-die policies where the policy covers two insureds and where insurance charges are low.

Loan Treatment of Private Split Dollar

Under a loan treatment, an appropriate interest rate, usually the AFR’s long-term rate, is charged to the ILIT for the borrowed premiums.  As with economic benefit treatment where the grantor typically gifts to the ILIT the amount needed to pay the ILIT’s portion of the premium, under a loan regime, the grantor gifts the amount to the ILIT required to pay interest on the premium loan balance.

The lower the AFR long-term rate, the more attractive it is to utilize the loan regime.  Given that interest rates are rising, those considering private split dollar should evaluate the likely total loan cost and compare it to the illustrated economic benefit.  It may be that a loan treatment is more attractive at the moment; though, as rates increase, this may not be the case.

C3 Financial Partners can assist in determining how premiums advanced under a private split dollar arrangement should be treated.

Repayment of Premiums

There are a number of ways to repay the greater of the policy’s cash value or the premiums paid.  At the death of the insured grantor, this amount can be repaid from a portion of the policy’s death benefit.  The trustee can also use the death proceeds to lend to the estate or purchase assets out of the estate, providing even greater liquidity if needed.

Alternatively, during the insured’s life, the split dollar arrangement can be repaid through a variety of wealth transfer strategies, including GRATs, CLTs, sales to defective trusts, or gifts.

Benefits of Private Split Dollar

There are several benefits to a private split dollar arrangement:

  • Minimize Gift Taxes – A direct gift of the premium might cause a major tax issue if the grantor has an insufficient gifting allowance or has exhausted their gift tax exemption. A private split dollar arrangement limits the taxable amount to the annual economic benefit or loan interest.
  • Minimal Costs – In many cases, the economic benefit cost is less than loan interest offered under private financing techniques, especially for second-to-die cases, making private split dollar an attractive alternative to private financing.
  • Retain Control – Rather than making an outright gift to the trust, resulting in a loss of control of the gifted funds, clients who use a private split dollar arrangement retain some control of their premium outlay since the premiums advanced can be ordered back at any time.
  • Estate Freeze – If the policy chosen does not provide a cash value greater than premiums paid, the amount due back to the estate is exactly the premium amounts paid, without growth.  This “freezes” the total amount of premiums/loans in the estate.

Intergenerational Split Dollar

A version of private split dollar, an intergenerational split dollar plan may involve three generations of a family as follows:

Step One:  Grandparent (or grandparent’s revocable trust) advances premium dollars to an ILIT,

Step Two:  The ILIT purchases life insurance on the lives of the children; and,

Step Three:  The beneficiaries of the ILIT are the grandchildren. The grandparent is typically the wealthier generation that can afford to fund the life insurance plan. But there are lots of variations.

One benefit of an intergenerational split dollar arrangement is that wealth is typically passed down two generations instead of one.  However, a second benefit is equally as attractive:  the estate of the grandparent values the donor’s interest in the premiums advanced with a significant fair market value discount. This is because it is likely that the donor will pass away many years before the insured, keeping the policy in force.  Therefore, on a present value basis, value of the advanced premiums is much less than full value.

Recent decisions handed down by the United States Tax Court have reinforced not only the intergenerational split dollar structure but also affirmed that the 2002 and 2003 Final Split Dollar Regulations continue to control the facts in similarly structured split dollar arrangements.

C3 Financial Partners can assess if an intergenerational split dollar arrangement is ideal for an estate plan involving multiple generations.

Sustain Wealth for Generations

Private split dollar may be an effective estate planning strategy that allows a client to pay annual premiums on a policy owned in an ILIT without having to make large gifts that would exceed the client’s lifetime exemption and incur gift taxes.  At C3 Financial Partners, we look forward to helping our clients gain clarity in their goals and objectives, confidence that they are making the right decisions, and coordinating with their other advisors.


For informational purposes only — this is not a specific recommendation. Consult with your tax advisor and attorney for more information for your specific situation.

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