After speaking with their financial professional, John and Marty have agreed that a family split dollar arrangement can help them provide the life insurance protection that can take care of their family estate planning needs without requiring large taxable gifts to pay the annual insurance premiums. Although this solution can be set up where Marty pays the premium, John and Marty have decided that John should be the premium payor.

This split dollar arrangement will be structured with the ILIT as the applicant and owner of the life policy insuring John’s life. John will pay the entire annual premium. John is the deemed owner of all of the policy cash value. Under the arrangement, if John dies, the ILIT will receive a portion of the insurance death benefit — an amount equal to the total policy death benefit less the whole life insurance policy cash value.

Since the ILIT does not pay for this insurance protection, John will be deemed to have made a gift to the trust each year equal to the value of the insurance protection that the ILIT receives. This value is based on the death benefit that would be paid to the ILIT multiplied by an age-based term cost factor. This gift by John can qualify for the annual gift tax exclusion, even though the ILIT will be the legal title owner of the policy.

Normally, in a split dollar arrangement, the premium payor would receive a collateral assignment from the policyowner and be able to take loans from the policy. However, if John received this type of collateral assignment, the death benefit would be includable in his estate. This would negate the benefits of having an ILIT own the policy. Therefore, in this situation, a “restricted” collateral assignment form must be used in order to avoid adverse estate tax consequences. This form will not allow John access to policy cash values during his lifetime. At John’s death, John’s interest in the cash value will be repaid to his estate out of the policy death benefit, leaving the balance of the death benefit paid to the ILIT and distributed pursuant to the ILIT’s terms.

John and Marty recognize that using a family split dollar arrangement means that the trust’s access to the policy cash value¹ will be limited, the term value treated as a gift will increase each year, and that as the cash value increases, the portion payable to the trust declines.

It is recommended that John and Marty consult their personal tax and legal advisors before implementing any strategy.