My father (of blessed memory) passed away last November at the age of 85. He was born and raised in the Saxon region on the Polish and Czech borders. I figure his town was the German equivalent of Hooterville. He came to the United States in 1953 as a refugee through Canada with nineteen dollars in his pocket. He had enough of the Russians as they probably had their fill with him as well. He made his exit from East Germany in 1952 by swimming across a river on the border studying the guards for a week before escaping. He was sponsored by the Chaplain of the U.S. Army as a refugee. He was a very gifted soccer player with an opportunity to play in the early equivalent of the Bundesliga but left for a new life in America.
The day that he arrived at Penn Station, there was a transportation strike that prevented his great Aunt from meeting him. No one spoke German and he spent his first night in America sleeping on a bench at Penn Station. He later worked for a family that owned and operated a bakery in Falls Church, Virginia. This family became his second family and my father remained in contact with them until their death but continued to have their only son who suffered with mental challenges as a visitor every year until the son died.
My Dad was drafted into the U.S. Army in 1954 before he could speak English. I never appreciated how difficult it must have been being a private in Uncle Sam's Army with a heavy German accent right after World War II. It was hard enough for me even without a German accent. He was stationed in Panama which ultimately led to his return to the Panama Canal Zone where he lived and worked for twenty-five years. He had a good career and had a long retirement and traveled to every continent making it to the South Pole a year before his passing. Growing up he rarely discussed his childhood. He lost his father during the WW II and saw a lot of horrible events during and after the war. I was fortunate to hear the stories of the "lost" years of the war and after the war before he passed. As a German, he was heavy on discipline and short on patience, but left with me with an eternal view that Father did know best, at least most of the time.
In the Canal Zone, we had very little TV limited to a few hours per day on the military TV channel. Most of the classic shows of the 1950's and 1960's like The Adams Family, and Father Knows Best were only available in Spanish. I did not see these shows until I came to the United States for my last two years of high school. In the show Father Knows Best, the character Jim Anderson, Sr., is a life insurance agent for the General Insurance Company. The character of Ward Cleaver, Beaver's father, in Leave It to Beaver, was also a life insurance agent. This article focuses on the resurgence of Split Dollar Life Insurance. The current low interest environment suggests that we give Split Dollar our undivided attention. The declaration of its demise in 2003 has been greatly exaggerated.
Equity Split Dollar - Old School
Equity Split Dollar was an excellent tax shelter in the best sense of the word. In business Split Dollar, the employer provided premium payments for a business owner or executive and minimal tax cost to the executive who accumulated an interest in the policy cash value and death benefit, in excess of the employer's interest. The company retained an interest in the policy cash value and death benefit equal to its premium payments while the executive enjoyed the excess cash value buildup without taxation on this buildup while being able to distribute this buildup on a tax free basis. Where the policy was owned by a trust, no gift taxation applied. The strategy enjoyed tremendous financial and tax leverage.
Presumably, many billions (maybe trillions!) of dollars of life insurance was sold using this planning concept over multiple decades. A combination of the life insurance lobby and life insurance agent lobby preserved the favorable tax treatment of Split Dollar. The bottom fell out of Split Dollar in 2003 when Congress adopted new Split Dollar regulations. The tax changes provided us with loan method Split Dollar which in the current low interest rate environment has resuscitated Split Dollar back from the dead.
Loan Method Split Dollar - New School
In loan method Split Dollar, the business owner or a family trust is the applicant, owner, and beneficiary of the policy. The employer provides a series of loans to the business owner as the policyholder or the trustee in a trust-owned policy. The employer receives a collateral assignment interest in the policy cash value and death benefit equal to its loan advances (plus any accumulated interest) which are used by the policyholder for premium payments. The policyholder makes interest payments annually or alternatively accumulates interest. The interest rate must be equal to or greater than the applicable federal rate which is likely to be the long-term rate which is 1.17 percent for July 2020. If not, the policyholder will be taxed under the below market interest rate loan rules. This Split Dollar loan rate can be locked in for the lifetime of the agreement. Alternatively, the agreement may use a demand loan which currently has a rate of 0.8 percent. This rate resets annually. The policyholder is entitled to the excess cash value and death benefit upon the collateral assignment interest. The policyholder has the ability to take tax-free loans. The policyholder's beneficiary receives the death benefit income tax-free. The death benefit is also estate tax free if owned within an irrevocable trust.
I wrote recently about the incredible financial benefits available through intra-family loans. When coupled with Private Placement Life Insurance (PPLI), the loan becomes supercharged allowing the policyholder to enjoy the growth of the borrowed assets without any income taxation or estate taxation where that is a planning concern. Traditional retail life insurance agents have long been enamored over the last two decades with equity index universal life insurance and premium financed life insurance. Nothing wrong with that! However, the cost efficiency and open architecture of PPLI provides greater financial and tax upside for the client. Plus, life insurance agents can now earn a large first year commission as part of the PPLI sale. Father knows best!
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