Using Premium Financing To Rescue Split-Dollar Plans
Between now and December 31 of this year a key theme among many financial advisors will involve how to handle existing client split-dollar arrangements. Planners have a wide range of options to consider with these clients.
Among the many options are:
Terminating the split-dollar arrangements and avoiding taxation on any equity buildup;
Maintaining the split-dollar program until the life insurance policy can better support itself–even though it may result in some taxation on equity buildup;
Never terminating the split-dollar arrangement, instead keeping the program in place until death;
Switching from a collateral assignment to an endorsement program; and
Maintaining an existing plan until just prior to the equity crossover point, then terminating with a note rollout.
Many variations of these choices exist, and other choices are available. Not every choice will work with all split-dollar arrangements. Some may not work numerically; some may carry financial or tax risks.
A key concern of advisors centers on those split-dollar plans where the life insurance cash values are insufficient to reimburse the premium payor and maintain the viability of the underlying life insurance contract. Where this is an issue, clients might wish to consider handling their split-dollar rollout through a premium financing arrangement.
Under this approach a new, independent lender essentially substitutes for the original assignor in a collateral assignment split-dollar arrangement.
Typically, the lender will advance sufficient funds to reimburse the original premium payor. This allows for the split-dollar plan to be unwound without raiding life insurance values. Once the loan is received from the new lender, the former employer can be paid off and exit the arrangement. This can allow for the rollout of a split-dollar arrangement before Dec. 31, 2003, without triggering any equity taxation.
Publicly traded corporations can eliminate their concerns under the Sarbanes-Oxley Act as employers are removed from the split-dollar arrangement and an outside, independent, lender steps into their shoes.
Where new, or ongoing, premium payments are required they can be handled via corporate bonuses, or through additional loans under a premium financing arrangement. Each year new advances can cover premium payments.
Some premium financing arrangements have steep minimums for each loan advance; this is to limit their costs associated with the loan underwriting in relation to the funds advanced. If the original arrangement called for smaller premium amounts, it is possible that the lenders minimums can still be met by restructuring the premium payment pattern. Often, fewer, but larger, payments might meet a clients objectives while meeting the minimum amounts for premium financing arrangements.
An example can be seen with Charlie and Stella, both 72 years old. They own a good-sized, closely held business. They determined some time ago, as part of an overall planning process, that they had a need for $5 million of death benefit to cover their estate taxes. They did all the right planning for the time; they set up estate documents that deferred estate taxes until the second death. They set up an irrevocable life insurance trust. The trustee purchased a survivorship policy on their lives and then set up an equity collateral assignment split-dollar plan with the business.
The split-dollar plan was set up in a way to handle a controlling shareholder and Charlie regularly has been reporting the economic benefit from the split-dollar plan in his income each year. That was seven years ago. The policy was a variable universal life survivorship, illustrated at 10%–an approach normal for the time.
Now, seven years into the program the business is owed $430,000 and the plan is just shy of having any equity. In other words, there are insufficient funds in the insurance policy to pay off the employer and maintain the life insurance death benefit.
The trustee has several choices–none of which are particularly attractive:
They can terminate the plan by giving the policy to the corporation;
The couple can continue the existing plan and rollout in about seven more years, based on the original illustration. Based on that illustration the couple would now face income taxation of about $500,000 equity, and they may also have gift tax consequences at termination;
The corporation can distribute its current interest to Charlie. He will be taxed on the income and will need to make a gift of the policy to the trust–an expensive approach. Future premiums will need to be handled by bonuses or other after-tax dollars gifted into the trust–adding to the expense;
