Service Rules Favorably on Private Split-Dollar Insurance

by Beverly R. Budin, Esq.
Ballard Spahr Andrews & Ingersoll, LLP
Philadelphia, PA


In PLR 200910002, the Service ruled favorably on the gift and estate tax issues in a split-dollar insurance arrangement. Husband and wife created an irrevocable trust (the “Trust”), which purchased a second-to-die life insurance policy on the lives of the settlors. The Agreement between the Trust and the settlors provides as follows:

1. The Trust will own the policy.

2. During the joint lives of the settlors, the Trust will pay an amount equal to the insurance company's current published premium rate for annual renewable term insurance generally available for standard risks; and after the death of one of the settlors, the Trust will pay an amount equal to the lesser of (i) the amount provided in Notice 2001-10, 2001-1 C.B. 549, or subsequent IRS guidance and (ii) the insurer's current published premium rate for annual renewable term insurance generally available for standard risks. The settlors (or the surviving settlor) will pay the balance of the premiums.

3. The Trust will collaterally assign the policy, giving the settlors the following rights:

a. At the death of the survivor of the settlors, the survivor's estate will receive the greater of the cash surrender value of the policy or the cumulative premiums paid by the settlors.
b. If the Agreement terminates during lifetime, the settlors (or surviving settlor) will receive an amount equal to the greater of the cash surrender of the policy or the premiums paid by the settlors “to the extent the trust has other assets.” [Nothing in the PLR indicates whether the Trust is to hold any other asset.]

4. Except as noted above, the Trust retained all other rights in the policy.
The Service ruled that the arrangement would not result in a gift by the settlors and the insurance proceeds would not be includible in either settlor's estate.

In reaching its conclusion regarding the gift tax issue, the Service weaved its way through the complex regulations in §1.61-22. The following should be noted:

1. The arrangement falls under the “economic benefit regime,” which measures the economic benefits to the Trust (rather than the “loan regime,” governed by §7872).

2. After the death of one of the settlors, the Trust pays the “lower of” the IRS table and the insurance company rates. While both settlers are living, there is no sanctioned IRS table to use and, therefore, the Trust pays the insurance company rates.

3. If the policy is maintained until the death of both settlors, the insurance proceeds will provide sufficient funds to pay the estate of the surviving settlor the greater of cash value and the cumulative premium payments of the settlors. Less certain is whether there would be sufficient funds to pay the settlors the “greater of” if the policy is terminated when one or both settlors are living. If the settlors' cumulative outlay for premiums exceeds the cash value, the settlors will get the “greater of” only if the Trust holds assets other than the insurance policy. The Ruling specifically states that the payment to the settlors in this circumstance is made “to the extent the Trust has other assets.” Therefore, until the cash value is at least equal to the total premiums paid by the settlors, it is the settlors who are “at risk” and not the Trust.

4. The ruling states that “if some or all of the cash surrender value is used (either directly or indirectly through loans) to fund the Trust's obligation to pay premiums, Settlor A and B will be treated as making a gift at that time. Therefore, as long as the policy is maintained, the settlors will be making gifts, either by making transfers to the Trust to fund the Trust's obligation or because the Trust borrows on the policy to do so.

5. A problem with this kind of arrangement is that the term insurance costs increase significantly as the insureds grow older. Perhaps in this situation the insureds are in less than ideal health and the use of the standard rates minimizes the gift tax impact of maintaining the policy. Perhaps the game plan is for the Agreement to be terminated at or near the point at which the cash value is equal to the cumulative premium payments of the settlors. At that point, the settlors would, in essence, get the return of their cumulative premium payments without interest.

This ruling provides helpful guidance for anyone contemplating a private split-dollar insurance arrangement.