Although the Treasury Department and the Internal Revenue Service have significantly diminished its income tax advantages, split-dollar insurance can still be a valuable estate-planning tool. The IRS's final regulations1 created the ability to use coordinated strategies to fund life insurance premiums without making any taxable gifts or, in some cases, triggering the generation-skipping transfer (GST) tax. Artful use of these strategies can result in substantial savings in the tax cost of buying new policies. They also can help remedy situations in which clients have existing split-dollar arrangements that need significant gift tax dollars to fix.

Be warned, though, structuring these arrangements under the new rules calls for careful planning. And these transactions need to be fully modeled under as many scenarios as are appropriate.


The final regulations recognize two types of split-dollar arrangements: economic benefit split dollar and loan split dollar. Economic split-dollar arrangements remain as previously defined. However, the value of the annual economic benefit is determined by Table 2001, with changes that may be announced in the Internal Revenue Bulletin, or, as the regulations put it: “the insurer's lower published premium rates that are available to all standard risks for initial one-year term insurance,”2 as strictly defined.

The second type, the loan arrangement, did not exist previously. By using a properly structured loan arrangement, a planner can devise transactions that create no taxable gifts and no GST transfers. In order not to be considered a gift, a split-dollar loan between the trust grantor and the irrevocable life insurance trust (ILIT) must bear interest at a rate that is at least equal to the applicable federal rate (AFR) for the appropriate time period. Interest in loan split-dollar arrangements may be paid currently or accrued and is not taxable to the grantor/lender so long as the trust remains a grantor trust.3


How should we build a split-dollar transaction that can minimize the gift tax cost if not eliminate it altogether? Consider the example of a 60-year-old man who is the grantor of an ILIT. The ILIT will be a grantor trust4 to avoid adverse income tax consequences to the grantor either as the interest accrues or when it is paid. The ILIT will not be generation skipping. The grantor has heeded your advice about the need for an exit strategy from the split-dollar arrangement and has funded a grantor retained annuity trust (GRAT), naming the ILIT as the remainderman.

The ILIT will be the applicant, owner and beneficiary of a $2.5 million policy on the grantor's life. After seeing various types of products and design alternatives, the client selected a current assumption universal life policy with a $33,879 annual premium and a level death benefit. The premiums will be payable until age 100. Because of the split-dollar loan, the actual death benefit remaining in the trust will decrease until the loan and accrued interest are paid off. In this example (if the assumptions are met), that will be after nine years. Note that the policy could be constructed so that the premiums for the first nine years are less than the ensuing ones, a design that could mesh nicely with the grantor's strategy for funding the ILIT with property.

The GRAT has a term of nine years. The grantor transfers an asset worth $1 million that can be discounted for gift tax purposes to $700,000. The asset conservatively throws off 6 percent income and grows at the rate of 5 percent per year. Based on an annuity payout rate of 14.4473 percent, and the April 2006 Section 7520 rate of 5.6 percent, the remainder value of a nine-year GRAT will be worth $.87.5

The grantor makes a non-recourse loan6 to the ILIT of $304,911, which is the undiscounted value of the first nine years' premiums. With interest accrued at the April 2006 midterm applicable federal rate (AFR) of 4.63 percent, the payment due to repay the loan at the end of nine years will be $458,225. The present value of the remaining premiums payable till age 100 using a 3.68 percent interest rate (the current composite rate on five year AA municipal bonds) is $620,337. The total required at the end of the ninth year from the GRAT to cover all these is $1,078,562.6 Based on our assumptions, the GRAT will have a remainder interest of $1,147,798, providing some margin of safety.

In other words, the assets in the GRAT have a discounted value and an anticipated return so that after making the annuity payments to the grantor, the remainder interest will be sufficient to pay off the split-dollar loan and interest — and have enough remaining to cover the payment of all future premiums. (A conservative discount rate based on highly rated municipal bonds is used to determine the amount needed after the loan and the accrued interest are paid.) The GRAT will have a zero remainder value at inception.

The trustee of the ILIT has the ability to renew all or any amount of the loan for whatever term the trustee determines up to nine more years, again at the appropriate AFR in effect at the time the loan is renewed. The renewal provisions allow for the trustee to continue renewing for a total of 20 years (an arbitrary number) from the end of the original loan. This gives the grantor and trustee some latitude if the original GRAT does not succeed to provide adequate funding to the ILIT as described above. The grantor then can create a new zeroed-out GRAT for some time so that the ILIT ultimately has enough funding to pay back the outstanding loan plus accrued interest and be able to pay all premiums going forward. The terms of the new GRAT will be decided based on the circumstances at that time.

Some planners might wonder why the grantor should go to this level of complexity to fund a relatively inexpensive policy. Using life expectancy based on IRC Section 1.401(a)(9) 2002 (adjusted for sex), the insured/grantor's life expectancy is 23.5 years. Let's look at the cash flows.7 The $1 million value for the assets in the GRAT plus the $304,911 loan to the trust are the going-in costs. The annuity payments of $101,131 due at the end of each year, the repayment of the loan plus accrued interest of $459,862 at the end of the ninth year, and the ultimate death benefit of $2.5 million plus the unspent balance from the GRAT of $498,931 paid at life expectancy (and not subject to income, estate or state inheritance taxes), are the monies benefitting the grantor and the trust. The internal rate of return is 8.11 percent — and all that without making a taxable gift. (See “Split-Dollar Loan with GRAT,” p. 43).


Significantly, what makes this plan work so well is the split-dollar loan, which by design does not result in a gift. Also, unlike a sale of assets to a grantor trust for a note, the trust does not need to have other assets.8 Coupled with a zeroed-out GRAT, there is no gifting at all.

But the GST amount cannot be allocated at funding. The value for GST purposes is the actual value of the remainder interest at the time the GRAT ends, making this unsuitable for generation skipping. This issue leads to the next transaction.

In this case, because we want to be certain of the premium payments, we will use a no-lapse universal life9 (NLUL) with premiums payable for nine years. The policy is structured with a combination of death benefit options and riders (depending on the carrier) so that the death benefit increases at roughly the same rate as the loan. Consider that the insured and grantor of the ILIT is a woman, aged 60. Based on annual premiums of $360,000 for nine years and a net, after-tax earnings rate of 3.55 percent (short-term triple-A municipal bonds), the loan to the trust is $2,275,133. The loan is for the cumulative amount of the premiums, and it is repayable at death. Under the split-dollar loan regulations, the insured's life expectancy determines the AFR to be used. It invariably is the long-term rate, which in April 2006 was 4.68 percent. If an insured survives past life expectancy, according to the regulations, the loan is considered retired and reissued at the same AFR on the day the loan was originally made.10 When the insured dies, the loan is repaid, plus the accrued interest, while the remaining death benefit goes into the trust. (See “Lifetime Split-Dollar Loan,” this page.)

At a life expectancy of 88 years, this scenario produces an internal rate of return of 7.19 percent. The loan amount will be in the estate as it might have been if the transaction was never done (especially if the client has used or is using gift tax exclusions and exemptions for other purposes), but that effect needs to be considered.

In other words, the grantor (actually, the grantor's estate) ultimately receives a rate of return better than current long-term municipal bonds on the money lent,11 and the ILIT will receive approximately $5 million. Because of the nature of properly-designed, private loan split dollar, there are no gifts and transfers for GST purposes.

A dynasty arrangement can be used in a trust established in a state that has no rule against perpetuities. That is, if the grantor of the trust desires, so long as there are beneficiaries who qualify, the trust can go on forever. A prospect for this arrangement, however, must be someone willing to give up the use of the loan money forever.


As with any other sophisticated technique, there are pitfalls. Life insurance itself has risks. Different life insurance products present varying issues.12 For example, a current assumption universal life (UL) can be inadequately funded or actual performance can be worse than projected, so that the policy does not support itself within the time (or gift tax) range anticipated by the grantor.

While NLUL does not have performance issues, these policies are based on the individual insurance company's guarantee. If something happens to that company's viability, it's problematic whether any company that assumes the business will continue the guarantee. Because these policies are akin to term insurance in later years (that is, they have no surrender value) the problem is exacerbated — without cash value, and without a guarantee, the policy lapses. Many NLUL policies require premiums to be paid on or before the due date to maintain the guarantee. If premiums are not paid when due, either the guarantee expires earlier than expected or the cost to make up for that timing difference can become significant.

If a participating whole-life product is used and the originally projected dividend scale is not met, premiums may have to be paid for longer than projected. In a whole life/term blend design, an insufficient dividend might retard the displacement of the term element with paid-up additions, which will require either more premium or more years of premiums.

A method of dealing with these issues is to have the original proposals run for as many years as the carrier's software allows. Many go well past age 100. In-force illustrations should be obtained on each anniversary to allow the trustee, owner and/or the insured to compare the actual performance and the new projected performance with the originally projected performance.

An insured should obtain coverage from highly rated carriers. The trustee, owner, and/or the insured should obtain rating reports when deciding on the carrier and review rating reports annually thereafter. In cases with larger face amounts, diversifying among carriers can help minimize risk.


Another set of issues involves funding techniques. Although labeled “final,” the IRS's final split-dollar regulations could be changed in the future. Though arrangements established under these regulations would likely be grandfathered, there are no guarantees. The same warning applies to GRATs, and GRATs have the additional issue of underperformance.

A grantor trust has its own issues. When accruing interest, the original issue discount (OID) rules apply. OID rules require that for a term loan, all future interest for the term be taken into account for tax purposes at inception. So, if the grantor also is the insured and he dies, only the last year's interest payment will be subject to income tax.

If a grantor trust subsequently loses its defective character (such as in second-to-die situations when the grantor is one of the spouses and that spouse predeceases the other), the interest payable going forward now is taxable under the same OID rules. This is problematic and militates against using second-to-die policies.

The new loan techniques can be used in existing (pre-Jan. 28, 2002) split-dollar arrangements to preserve most of the previous tax benefits. Old split-dollar arrangements can be changed to loan arrangements if all the premiums paid up to the time of the change are treated as a loan from the date of the change forward. Also, if an existing split-dollar policy is exchanged for a new policy, that may be considered a material modification under final regulations that subjects the arrangement to the new rules.13 Existing life insurance programs other than split dollar that have gifting issues also may benefit from some application of the loan arrangement.


For gifting advantages, the loan split-dollar transaction is superior to premium financing transactions even when the client is borrowing to pay premiums.

For one thing, the interest rates used in loan split-dollar transactions are lower than the London Inter-Bank Offered Rate (LIBOR) plus an add-on (the rates used in premium financing). The 12-month LIBOR rate in March 2006 was 5.25 percent. The April short-term AFR was 4.66 percent and the midterm AFR was 4.63 percent. With the addition of anywhere between 100 and 300 basis points to LIBOR, which is the going rate for outside-financed premiums (6.25 percent to 8.25 percent with the add on), a loan split-dollar arrangement is simply better.

Also, the interest rate in a loan split-dollar arrangement can be locked in for the time period desired by selecting the appropriate length of the loan — and therefore the AFR — for the repayment. To lock in a LIBOR rate, an additional derivative transaction is involved (an interest rate swap), adding to the cost. That swap can only be used for a limited period of time before it expires. In loan split-dollar transactions, in exchange for putting up the capital (or borrowing it from another source) the grantor becomes the bank and has more control over the transaction.

But there's also another advantage: Premium financing requires collateral beyond the policy, mostly in the form of personal guarantees or letters of credit. Under the split-dollar regulations, no collateral beyond the policy is required.


While the final regulations on split dollar caused much consternation at first and remain challenging to understand, their important elements are clear. And the opportunities that they afford are becoming ever clearer. It's possible to structure arrangements that avoid gifting issues and will withstand IRS scrutiny.

Moreover, when making use-of-money calculations, clients may realize savings of 50 percent or more over the outright payment of premiums — without taking into account the additional value of avoiding gifting issues. When life insurance is involved in a client's estate planning, split-dollar arrangements clearly are of value and should be given a good look.


  1. 26 Code of Federal Regulations Parts 1, 31 and 602 which include amendments and insertions to Treasury Regulations under Sections 1.61-22, 1.83-3(e), 1.83-6, 1.301-1(q), 1.7872-15, 31.3306(b)-1 and 31.3401(a)-1.
  2. Revenue Ruling 2003-105 preserves the language of Section III, paragraph 3 of Notice 2002-8.
  3. See Rev. Ruls. 2004-64 and 85-13.
  4. Because this and other methods involve the use of grantor trusts, to effect such a trust without causing estate tax inclusion involves proper documentation. In the split-dollar loan agreement, the grantor-lender's rights should be restricted. See Private Letter Rulings 9511046, 9745019 and 9809032. The “defect” that causes grantor trust status should not be one that causes estate tax inclusion.
  5. The source is NumberCruncher 2006.00, by Stephan R. Leimberg and Robert T. LeClair.
  6. Because this is a non-recourse loan, it is incumbent upon both the trustee of the irrevocable life insurance trust (ILIT) and the grantor to have a letter attached to their income tax returns each year stating that a reasonable person would expect that the loan will be repaid. Otherwise, under the terms of the regulations cited above there would be contingent interest under Internal Revenue Code Section 7872 and a “deferral charge.”
  7. Ibid.
  8. Please note that it appears that an insurance policy sold through an installment sale to a grantor trust and then used as collateral for the loan will come under the split-dollar regulations. This begs the question that if it is split dollar, does there have to be any seed money in the trust?
  9. For more information, see Timothy P. Malarkey and Stephan R. Leimberg, “Innovative Planning With No Lapse Guarantee Life Insurance,” Estate Planning, July 2005.
  10. Treas. Regs. Section 1.7872-15(e)(5)(ii)(D).
  11. As of this writing, the composite rate on AAA 20-year municipal bonds is 4.23 percent.
  12. Because the risks and the complexities of different life insurance policies merit at least a separate article, they're not explored in depth here. An excellent readable and understandable book on the subject is Richard M. Weber's Revealing Life Insurance Secrets — How the Pros Pick, Design, and Evaluate Their Own Policies, Marketplace Books, 2005.
  13. Treas. Regs. Section 1.61-22(j)(2)(I-ii), particularly (ii), in which “non-material modifications” are described. The absence of tax-free exchanges under IRC Section 1035 on the list is problematic.


If a trust only receives a split-dollar loan, there's no gift and inclusion for GST tax purposes

On a $5 million initial face amount for a female aged 60, premiums for nine years are $360,000.

Age Loan Balance Net Death Benefit to Trust
60 $2,381,609 $4,978,431
61 2,493,068 4,959,227
62 2,609,744 4,942,621
63 2,731,880 4,928,859
64 2,859,732 4,918,203
70 3,594,544 5,703,536
75 4,518,168 5,889,477
80 5,679,119 6,124,520
85 7,138,378 6,421,640
86 7,472,454 6,489,885
87 7,822,165 6,561,404
88* 8,188,242 6,636,355
*life expectancy
Source: Richard L. Harris


The benefits can be considerable as long as you use a split-door loan so that there's no gift

For a $2.5 million life insurance policy on a male aged 60, the annual premium(, which will be funded by a non-recourse loan, is $33,879. By the time he's reached his life expectancy of 83 years, the net death benefit to the trust will be close to $3 million.

Cash to and from Trust Age Cash Account Loan Balance Net Death Benefit to Trust
Loan In $304,911 60 $271,032 $319,028 $2,452,004
61 237,153 333,799 2,403,354
62 203,274 349,254 2,354,020
63 169,395 365,425 2,303,970
64 135,516 382,344 2,253,172
65 101,637 400,046 2,201,591
66 67,758 418,569 2,149,189
67 33,879 437,948 2,095,931
68 0 458,225 2,041,775
GRAT Proceeds In Loan Repayment Out $1,147,798 -$458,225 69 679,824 0 3,179,824
70 669,715 0 3,169,715
75 613,313 0 3,113,313
80 545,740 0 3,045,740
81 530,697 0 3,030,697
82 515,101 0 3,015,101
Life Expectancy 83 498,831 0 2,998,931
Source: Richard L. Harris