Most clients' estates will fall well within the current million federal tax exemption. Consequently, private split-dollar (PSD) life insurance plans have lost some of their appeal as an intergenerational wealth transfer method.
Doug Peete, ChFC and a Million Dollar Round Table member with Douglas R. Peete & Associates in Overland Park, Kansas, says PSD and other gift-leveraging techniques are still valuable planning strategies but generally only for ultrawealthy clients. "The vast majority of our clients are going ahead and just making gifts against their exemption equivalent because their law firms feel that's a better method of doing it," he says.
Tax regulations allow PSD to use either an "economic benefit regime" or a "loan regime" to determine applicable income taxes. Under the economic benefit regime, gift taxes on premiums paid are based on the value of the life insurance protection, which can be much lower than premium expenses. In loan regimes, premium payments are treated as loans. Under IRS regulations: "The repayment is to be made from, or is secured by, the policy's death benefit proceeds, the policy's cash surrender value, or both."
Applications
Peete shares an example of using PSD with second-to-die coverage with a wealthy couple who own a profitable business and want to take advantage of gift tax leverage. The husband is age 65, the wife is 60, and the life survivorship policy pays a $15 million benefit on the second death. He estimates the policy's annual premium would be about $150,000, and the policy would be owned by an irrevocable trust to keep the proceeds out of the clients' estates.
The business's value is increasing, pushing the clients' estate values higher, so the couple wants to transfer company stock to their children up to the allowable legal limits. Valuation discounts on the transferred stock provide gift leverage, as do the imputed gift amounts for the policy's premiums, which are less than the annual premium expense under the economic benefit regime. "On a $15 million insurance contract, the imputed gift (for the premiums) is less than $2,000 a year based on the 2001 tables," he explains. Instead of using up their annual gift tax exemption on the premium and filing a gift tax return, the lower imputed PSD gift lets the couple retain most of their annual exemptions for stock transfers.
Peter McCarthy, senior advanced marketing consultant with Voya Financial's insurance solutions business says that some advisors are combining PSD valuation methods in the clients' plans. He cites clients establishing an irrevocable life insurance trust to purchase a survivorship policy. While both spouses are alive, they pay the premiums through an economic benefit regime to keep gift taxes low. After the first spouse dies, however, the economic benefit cost will rise dramatically, he notes. To prevent this, the trustee terminates the economic benefit method and replaces it with the loan method. All premiums paid before the first spouse's death are converted into a loan to the trust.
McCarthy reports that his group is seeing the loan method used more often because it's easier to understand and less costly to implement. Interest rates are low, which has made clients more comfortable with the method, and "although the annual interest costs can't be ignored, clients can choose among several viable strategies to handle them," he said via email.
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