The benefits of a split-dollar with second-to-die policy
Tax Facts | National Underwriter Company
A recent letter ruling determined that with regard to a proposed split-dollar agreement between the insureds and a trust using a second-to-die life insurance policy, the insureds would not be treated as though they were making annual gifts, and policy proceeds payable to the trust would not be includable in the insureds' gross estates for estate tax purposes. However, policy proceeds payable to the estate of the second-to-die would be includable in such insured's gross estate.
Let's examine this scenario with the following example.
Alice and Bob, a married couple, created an irrevocable trust. Neither Alice nor Bob are permitted to serve as trustee, and neither has any power or authority over the trust.
The trustee is required to distribute trust income annually to a class of beneficiaries consisting of Alice and Bob's living issue, other than their children. Each member of the class also has the noncumulative power to withdraw their share of any contributions to the trust (a Crummey power). The trustee also has a discretionary power to distribute corpus to a member of the class for the beneficiary's health, education, support and maintenance. If a member of the class dies survived by issue, the surviving issue becomes members of the class. The trust will terminate on the later of the death of the second to die of Alice or Bob, or when the number of class members reaches 40 (or earlier, if required to avoid violation of the rule against perpetuities). Upon termination, the trust will be divided among the class members.
The trust has purchased a second-to-die policy insuring Alice and Bob. The trust proposes to enter in to a collateral assignment split-dollar life insurance arrangement with Alice and Bob. Under the agreement, the trust will continue to own the policy. During the joint lives of Alice and Bob, the trust will pay an amount equal to the insurance company's current published premium rate for annually renewable term insurance generally available for standard risks. After the death of the first to die of Alice or Bob, the trust will pay an amount equal to the lesser of the Table 2001 rate or the insurance company's current published premium rate for annually renewable term insurance generally available for standard risks. Alice and Bob will pay the balance of the premiums.
If the split-dollar agreement terminates at the death of the second to die of Alice or Bob, the estate of the second to die has the right to receive the greater of the cash surrender value of the policy or the cumulative premiums paid by Alice and Bob. If the split-dollar agreement terminates before both Alice and Bob die, the survivor of Alice or Bob has the right to receive the greater of the cash surrender value of the policy or the cumulative premiums paid by Alice and Bob, to the extent the trust has other assets.
Alice and Bob have no other interest in the life insurance. All incidents of ownership in the life insurance are vested in the trustee.
The letter ruling determined that neither Alice nor Bob would be treated as making a gift to the trust by reason of the payments on premium made by Alice and Bob. In essence, Alice and Bob retain a collateral interest in the policy equal to the premiums paid by Alice and Bob. The ruling noted that no opinion was being expressed regarding the gift tax consequences between Alice and Bob of the second-to-die policy.
The letter ruling also determined that the life insurance proceeds payable to the trust would not be includable in the gross estate of the second to die of Alice or Bob under IRC Section 2042(2). Neither would hold an incident of ownership in the policy insuring their lives. However, the life insurance proceeds payable to the estate of the second to die of Alice or Bob would be includable in such decedent's gross estate under IRC Section 2042(1).
*For further information, or to contact this author, please leave a comment and your e-mail address in the forum below.