Split-Dollar Arrangements for Life Insurance — An Overview

Split-Dollar Arrangements for Life Insurance — An Overview

By: Martin M. Shenkman, CPA, MBA, JD

Introduction to Split-Dollar

A Split-dollar arrangement is a way of funding the purchase of life insurance between two parties. It is not an insurance policy. In split-dollar, one party provides the majority of the funding while the other party controls most of the death benefit. Split-dollar insurance can be used in an estate planning context to help fund insurance purchases when there are not adequate annual gifts (presently $12,000/year) to do so.

Application of Split-dollar

What are the economic benefits of split-dollar? One party can make an advance, not a loan, to another party, in a form such as an insurance trust (ILIT). The party that makes the advance is entitled to receive back the greater of their cash outlay or the cash surrender value of the life insurance policy. Because that party gets any death benefit over and above the outlay or cash surrender value, there is an economic benefit to the trust. Each year this is measured by the cost of one-year term insurance. The IRS has issued Table 2001 showing the cost at each age. This gets expensive as the insured gets older, so a mechanism is needed to unwind the arrangement.

Second to Die Split-dollar

If two people are insured, the table addresses the likelihood of both people dying in the same year. The likelihood of both dying in the same year is low, so the economic benefit is very low. However, once the first of the insured dies, the single life Table 2001 will then be used, and the benefits will be calculated based on standard insurance.

Exit Strategy

Exit strategies do exist in this type of arrangement. You could, for example, use a low value GRAT. It has little value currently, but it will have a value when the GRAT ends, and then the ILIT can use that money to pay back the advance to the payor. The taxable term costs end. There should be no gain since the policy won't have that much cash value. The trust should be structured as a grantor trust to avoid a transfer for value rule. Recent IRS rulings give examples that provide some security to this determination.

The IRS, in 2003, created another variation of split-dollar, called "loan split-dollar" or "collateral assignment split-dollar". This is when an individual makes a loan to another party that is used to purchase the insurance. The lender receives back a note that bears interest. The interest can either be paid currently or accrued. However, if you want to avoid the interest being considered either a gift or a below market loan, the interest has to be pegged at the applicable federal rate published monthly by the IRS. The short-term rate is for 3 years or less, mid-term for 3-9 years and the long-term rate for more than 9 years. Demand loans are the fourth category, and are the average of the January and July short-term rates for the year. So long as the interest rate at minimum equals the Applicable Federal Rate, or AFR, there are no tax consequences.

The ILIT owns the policy outright, and has an obligation to repay the loan to the individual in the future. Once the loan is made, the trust can pay interest or accrue interest. If interest is accrued, you must have a grantor trust to avoid adverse income tax consequences. If, for example, the loan is to be repaid at death, and the insurance policy is structured for the value to increase, the insurance can cover the loan and the interest. This technique only works for older insureds. Otherwise, you still need a method of getting money into the insurance trust, or ILIT, to repay the loan. A GRAT (grantor retained annuity trust) with the ILIT as the named beneficiary can be used to accomplish this.

An interesting transaction can be created with a large one-time loan to the trust. You must understand the definition of split-dollar to understand this technique. If you make a loan to the ILIT, and it is collateralized by the death benefit or the cash value, or both, of the life insurance policy, then, by definition, it is considered a split-dollar loan. The trust uses this large one time loan to buy a policy, and to invest the balance of the money. Interest then accrues on the loan. The policy is structured so that premiums disappear at some point in the future. A secondary guaranteed universal life policy would fit the bill for this. The insurance company will guarantee that if you make specified payments, the policy will be guaranteed for some period of time, up to life. Some insurers illustrate these policies to age 121. At some point in the future, the loan will be repaid from the money in the trust, and the loan is then terminated. You will be left with a fully paid for insurance policy, and no taxable gifts. No gifts have occurred, because it has been a loan from inception. This is advantageous over the GRAT approach, since there is no inclusion ratio for this technique and this technique can be used to set up an insurance dynasty trust.

Split-dollar and Dynasty Trusts

Another twist on the above can present further planning opportunities. Instead of loaning cash, you can loan an asset to the trust. Use the cash flow to pay the premiums and use the same asset to repay the loan. You'll have to use a discounted value of the asset on the repayment. This is a great technique for those with non-liquid assets, such as real estate, to fund an insurance dynasty trust.

IDIGIT/Defective Trusts and Split-dollar

An intentionally defective grantor trust (IDIT) is a popular technique to transfer assets. Generally, however, this technique requires that the trust has some funding, although there are differences in opinion on how much funding needs to be used. This could require a taxable gift to "seed" the trust. Because the split-dollar transaction described above is covered by the split-dollar regulations, it could offer another method to accomplish a seeding of a trust without a gift tax. The death benefit of the insurance policy could be used to repay the loan, instead of using the assets transferred to the trust to repay the loan.


Split-dollar is complex, but offers significant planning opportunities in a number of estate planning circumstances. Knowing what all of your options are can help you select the best structure for you.


© Law Made Easy Press, LLC.

The discussions above are general and complex, and competent legal and tax advice must be sought before implementing any of the ideas discussed.

Our Consumer Webcasts and Blogs

Subscribe to our email list to receive information on consumer webcasts and blogs, for practical legal information in simple English, delivered to your inbox. For more professional driven information, please visit Shenkman Law to subscribe.

Ad Space