For many high net worth individuals, life insurance is the most common way to plan for the inevitable estate tax. However, for the proceeds to be free of estate tax, the insured cannot have any “incidents of ownership” of the policy, and therefore the policies are typically owned in an irrevocable trust outside of the individual’s estate. The trust, via the trustee, will make all necessary premium payments, be named as the primary beneficiary of the policy and administer the death benefit on behalf of the insured’s intended beneficiaries.
Since life insurance premium payments can be costly, the insured needs to be certain that premiums are paid on the policy without any transfer tax consequences to the insured during his or her lifetime. The question then becomes, how can this be accomplished?
One answer to the above question is through split dollar agreements, which is a highly effective estate planning technique for high net worth individuals. It is essentially a strategy in which an individual can utilize a series of separate annual loans in order to make premium payments for his or her life insurance policies. This arrangement is also common for employers who provide life insurance for highly compensated employees as a supplemental benefit.
Split dollar life insurance is especially useful for those individuals who would like to have their life insurance policies owned in an irrevocable trust, yet do not have the necessary annual exclusion amount available (currently $14,000 per year per beneficiary) to pay the full premium amount.
The strategy works as follows. Prior to the premium payment, an individual will enter into a loan agreement with the irrevocable trust for the stated applicable federal interest rate (AFR). This process will continue each year until the death of the insured.
Upon the insured’s death, the lending party will be paid off from the amount of the death benefit. The remaining death benefit will pass to the irrevocable trust or other designated beneficiaries tax-free.
If you are an individual who will ultimately be subject to the estate tax, it is extremely important to facilitate the necessary planning. Please do not hesitate to contact Morris Law Group to discuss how a split dollar agreement may be helpful to achieve such estate planning goals.