‘Splitting Your Dollar’: How to Take Advantage of This Strategic Estate Tax Planning Method
Under the current Unified Estate & Gift Tax Credit of $12,920,000 per individual expiring at the end of 2025 and a new estimated reduction of $6 Million per individual, many Americans now find themselves reevaluating their estate plans. Given that this is a “use-it-or-lose-it” situation, one fact has become crystal clear: one should absolutely be taking advantage of this lifetime exemption.
But what comes after you’ve already used all of the exemption and commonly used estate planning strategies, such as Grantor Retained Annuity Trusts (GRATs) and sales to irrevocable trusts, only to hit a roadblock? In truth, all of these legacy planning techniques come with their own set of issues.
With GRATS, the estate tax problem is simply transferred to the children who possess their own sizable estates, with prior family gifting, offering no intergenerational wealth preservation benefits. If a person engages in a sale of assets to a family trust—a highly effective “estate freezing” technique—but retains a “note,” the resulting note is includable in their estate for around 70 percent of the sold asset’s appraised value.
However, if you find yourself in the small percentage of those who have used their lifetime exemption, executed all of the common planning techniques, and still have sizable estate tax exposure in you or your childrens’ generational level, then you might want to consider a strategic life insurance arrangement commonly referred to as “Intergenerational Split Dollar.”
It’s important to denote that the Split Dollar Arrangement is not a type of insurance, but an approach to funding a life insurance policy and sharing—or ‘splitting’—the proceeds at the insured’s time of death. As defined by Treasury Regulation Section 1.61-22(b), the strategy is “an arrangement between an owner and a non-owner of a life insurance contract” in which a third-party serves as a “donor” of the premium, and is thusly entitled to recover and secure those premiums in the form of proceeds from the life insurance contract.
The Donor—or Grantor—then maintains the right to be repaid the greater of the cash value or the aggregate premiums paid; this is referred to as the right of reimbursement, and is typically paid upon death unless the agreement is terminated by mutual consent of the Donor and the trust or trustee, as outlined in the Split Dollar Regulations of 2003. For ease of understanding, experts refer to this as the “Split Dollar Note” — AKA, the “note.”
The note can be transferred by the Donor into another trust through a sale, gift, or some combination of the two at an appraised value. Recent court guidance suggests that, at the time of transfer, it’s possible that the economic value of the note can be substantially lower than the principal and accrued interest, presenting an additional estate planning opportunity. Since the note accrues all interest, and is not payable by the Grantor Trust to the Grantor until after the death of the insured, appraisal of the note may be valued at a substantial discount of 70 to 80 percent.
The end result is that one can dramatically reduce or eliminate gift, estate, and generation-skipping transfer taxes on intergenerational wealth transfers where the client has a genuine desire to benefit the next generation and beyond. Targeted assets can be income or non-income real estate, company stock, securities, and even art. Taxable QTIP assets and completed GRAT assets can be transferred into a non-taxable Dynasty Trust for generations. As well as, providing an excellent solution for moving out notes from one’s estate from completed sales to irrevocable trusts.
Thanks to recent tax court cases, litigation has provided a clear and discernible roadmap of acceptable circumstances and fact patterns for Split Dollar planning, and has provided an opportunity for many ultra-high-net-worth families to further accomplish intergenerational wealth planning, saving them tens to hundreds of millions of dollars in estate taxes.
About: Norton Advisory Group, a Member of PH Robb Legacy Alliance, is a boutique insurance consulting firm with a strong emphasis on estate planning and tax mitigation. For more information on advisory and other services, please contact Irene Norton at Irene@nortonadvisorygroup.com.
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