Advisory Collaboration and Intergenerational Split-Dollar Plans
in the January 2022 issue of trusts and estates, I wrote about how estate planning lawyers and tax advisors can work with life insurance professionals to create comprehensive, client-focused presentations of sophisticated life insurance strategies. In this article, I will focus on a strategy that has received a lot of attention recently.
Your clients are a wealthy couple who will proudly tell you (an estate planning attorney for the purposes of this example) their successful children and their beautiful and very smart grandchildren. The clients I will refer to as “GPs” tell you that their insurance professionals propose a plan called “Intergenerational Split Dollar” or “IGSD”. GPs say the plan involves setting up an irrevocable life insurance trust (ILIT) for the benefit of their grandchildren, who will own large life insurance policies on their children (and perhaps their children’s spouses if Both must be insured together). GP will provide funding for insurance through a split-dollar arrangement with ILIT. When the child/insured(c) passes away, probably several decades from now the ILIT will repay the GP. Obviously, if the plan is structured properly, it can provide significant tax and money transfer benefits for the family.
a collaborative effort
The GP wants you and the tax advisor to work with life insurance professionals to give them a realistic assessment of the plan. By “realistic” he means, “does it work?” Smart, knowledgeable, curious and detail-oriented in their planning, they are asking you to go beyond whether the plan keeps the water at a high level tax-wise. They are talking verbatim. They are talking about economics. They are talking about risk-adjusted returns. Talking about making today’s solution not tomorrow’s problem!
You tell clients that you are familiar with IGSD and that you have followed developments in case law, including a recent case that was settled favorably to the taxpayer. But you are never involved in those transactions. Perhaps tax consultants have some practical experience with IGSD.
You and tax advisors have an initial call with insurance professionals with whom you have worked well before. He suggests that you put together a few points that he can seamlessly weave into his general presentation on IGSD. “Take off the filter. If something is of interest or concern, ask us to address it,” say insurance professionals. “Understood,” you say, “we’ll get to work.”
Following a fresh review of the cases and comments on IGSD, you and tax advisors have a good grasp on both the opportunities IGSD can offer as well as the issues it presents. Now the mission is to cross-check the tax-oriented commentary on IGSD to get into the practical things that actually make it work…or not. In other words, the mission is not just about the discounts that all the press is getting but it is also about No Underestimating the importance of understanding how the scheme will play out in real time over the decades that it is implemented.
Here is the current, somewhat annotated version of the list, which you and the tax advisor insurance professionals hope to help you refine so that everyone avoids a lot of back and forth that delays a GP’s response.
- Is it going to be a non-equity collateral assignment plan (contributory or non-contributory) under the economic benefit arrangement, a collateral assignment scheme under a loan arrangement or the former with a switch to the latter at some point? These days, what facts and circumstances suggest one regime to rule over another?
- Describe and, if possible, show the schematic by parts, structure, mechanics, dollar flow and, of course, any assumptions that are critical to the plan’s success. Given C’s varying age and medical history, as well as the possibility that the IGSD plan could be in place for decades, it would be helpful to break the description down into phases or scenarios, perhaps in this order:
- On Day 1, as implemented.
- GP dies, is survived by C. This is important because the plan will survive the GP and continue with the GP’s successor. We will need to see (or find out) what will happen to “receivables” so that we can consider the legal, tax and economic implications of maintaining the plan after GP.
- C dies while GP is alive. At that time the GP will be repaid.
- Assume that under a second-to-die policy under a non-equity economic benefit scheme, one of the C dies while the GP is still alive.
- C (or the second insured under the second insured policy) dies after the demise of the GP.
- The plan has been scrapped, while everyone is still alive. We realize that there may be many subsets in this scenario. we will discuss.
- Note that we understand that we may modify or add to the scenarios listed above, based on insights you have on plan design from working on these cases with physicians and colleagues across the country.
- Provide the policy illustrations provided in Key of the Conservative.
- sample document.
- For each of the above scenarios, determine your understanding of operative tax guidance for Income, Gift, Property and Generation-Skipping Transfer (GST) tax implications. If there is no change from the earlier scenario, just let us know. We welcome any insight from the advanced planners at Carrier.
- Address the implications of the closure of ILIT’s grantor trust before the plan ends. We are assuming that the ILIT will be a grantor trust to improve the tax position of the GP in a contributory non-equity plan or debt-based plan.
a switch in plans
- So in order not to disrupt the flow and concurrency of the discussion, let’s address as a separate topic, Midcourse switches from a non-equity collateral assignment scheme to a debt arrangement scheme.
- When and why would you recommend the Switch? What would be the steps involved in that transaction? Would it matter whether the switch happened before or after the GP’s death? What will be the tax issues as you understand them?
Benefits of the plan
- Tax, economic and estate planning benefits that the plan can provide for the family.
Risks and what-ifs
Because we know customers will ask:
- For each type of plan, what can go wrong, and how will this event affect each side? For example, what happens if the policy “underperforms?” If one of the two insured dies early but the survivor dies and so the plan lasts for a very long time, what happens to the tax economics of a non-equity plan with a second-to-die policy? What if the term loan(s) have to be reissued at very high interest rates?
- In each case, if this happens, what can be done, from minor changes to actual exit strategies?
- What if, for whatever reason, parties C or both want to exit the scheme before C’s demise?
- How will they do that? What will be the tax and economic implications? It may all depend on the “when”.
- What will be the tax implications if ILIT surrenders the policy and pays it to the GP or his successor? Grantor trust status will probably come into play here.
- What if ILIT cannot pay the GP in full?
You send the list to insurance professionals who, as expected, ask you to give them a little more context at some point and give some suggestions of your own for a more comprehensive presentation. You give progress reports to GPs, who appreciate collaboration because they know collaboration “works.”