How to Have your Cake and Eat it Too

Grandparents sharing cake with grandchild

The recent tax reform has left some people wondering whether estate planning is still necessary. It is (we discuss this in detail here). If you die after 2026, the estate tax exemption goes back to 2017 limits (around $5 million or so).  Above that, your children will see 40% of your wealth go to the federal government. In some cases, they will have to sell off some of their inherited assets to cover the IRS bill. You can give now to take advantage of the higher estate/gift tax exemption, but there is another solution that allows you to keep your assets now (have your cake), while still ensuring more of your wealth is transferred to your children and grandchildren (and eat it too).

A Family Split Dollar arrangement can help preserve your estate.  You can transfer money to the next generation without triggering estate and gift taxes via a life insurance policy held in trust.

How is this possible?

Tax laws allow for a Family Split Dollar arrangement, in which Generation 1 (G1) purchases life insurance for Generation 2 (G2, their children) but it has to meet certain conditions:

  • The policy has to be permanent life insurance, and the money has to be repaid (via cash value in the policy, or by mutual agreement).
  • The life insurance policy can be financed by G1, in which case the cash value operates as collateral for the loan (along with other assets if need be).

The Benefits:

  • Financing the policy allows G1’s assets to continue to grow without interruption, potentially creating even more wealth for the next generation. This reduces opportunity costs for G1.
  • G2 may not be able to afford the level of life insurance they would need, so this is a great way to help them ensure their legacy. They can repay the bank loan that was used to purchase the policy on their life by using cash value from the policy.
  • Generation 3 (G3) will be named as beneficiaries, so the death benefit and any remaining cash value will flow to the 3rd generation, tax-free. This death benefit can be used to cover estate taxes.

The Process:

  1. The lender provides a loan secured against the policy cash value.
  2. G1 and G2 set up a Family Split Dollar agreement, and G1 uses the loan to fund a trust for G2.
  3. G2’s trust uses the funding to purchase a life insurance policy on G2’s life, with G3 named as the beneficiary.
  4. Grandma and Grandpa (G1) rest assured that their grandchildren (G3) will be taken care of long after their death.

This is a good fit for families with very high net worth, or with much of their wealth held within illiquid assets (such as property). They can avoid selling the assets if they are instead used as collateral for a life insurance policy. It is also a good fit for cases in which G1 is older, or in poor health. This is because the policy is taken out on G2’s life, which is much more palatable for an insurance company.

There are risks involved, including interest rate risk, policy performance risk and other factors. You’ll need to speak with an experienced professional to determine whether this is a right for you (or your affluent clients). If you’re not sure where to begin, please reach out to us. At Axia Global, it is our goal to make a measurable difference in your financial life.

Note: the statements above should not be considered financial, legal or tax advice, but ideas for careful consideration with your trusted financial advisors and lawyers. For current tax or legal advice, please consult with an accountant or an attorney.