Using the Leveraged Split Dollar Rollout (LSD™ Rollout) to Terminate Loan Regime Split Dollar™ Plans
Over the last several weeks, I have written a series of articles focusing on the planning utility and financial and tax leverage of the Loan Regime Method of Split Dollar™ life insurance. I have highlighted the timeliness of this planning technique considering the current low interest rate environment. The long-term applicable federal rate (AFR) for August 2020 is 1.12 percent.
I have shown how corporate or individually owned policies can be converted into the Loan Regime Method of Split Dollar™ (Late Start Split Dollar). I have also shown how Collateral Assignment Split Dollar Arrangements using the Economic Benefit Regime can be "switched" into the Loan Regime Method of Split Dollar™ (Switch Dollar). In these articles, I have loosely referenced in some planning examples the use of the Leveraged Split Dollar™ (LSD™ Rollout) technique to terminate the Split Dollar Arrangement. This article will focus on the LSD™ Rollout Method.
In these articles, I have also taken you down memory lane providing you with my own unique version of the Wonder Years (Estilo Panameño) because of my experience growing up in the Panama Canal Zone. It was an "outside looking in" American childhood experience with many of the vestiges of growing up in America but situated in the tropics. I always liked Joe Cocker and recently renewed my enthusiasm after viewing his documentary on Netflix, as the best white soul singer in Rock and Roll history. When Ray Charles says that you have "Soul," you have Soul! Joe Cocker’s signature album was called Mad Dogs and Englishmen. Hence, the basis for the title of this article but with the twist of my childhood experience in Panama.
Our " Wonder Years," always include stories about our childhood pets. While I did have a neighbor that had an ocelot and a sloth, most of us in the Canal Zone grew up with dogs and cats. My family had two dogs - Snoopy, a mutt and Fritz, A German Short-Haired Pointer. Fritz’s AKC registered name was Schumachers’s von Fritzel. Fritz always enjoyed special status with my German father (of blessed memory) because he was German. My father could always, speak to Fritz in German. It was their thing! He even survived the death penalty with no penalty, after devouring my Dad's order of German sausages from Usinger's in Milwaukee, on the day that they arrived. Snoopy would not have enjoyed the same result. Snoopy used to run the streets of our neighborhood with her pal, a black lab named Mingo.
The tropics are no friend to Man's Best Friend. Fritz met his end way too soon after being bitten by a poisonous snake in the field by our house. A virus several years later would kill most of the pets in the Canal Zone. My brother and I cried like we had never cried before! My mother said that my father also cried like a child when he heard the news about Fritz from the neighbor who found him. The Wonder Years!
Overview of the Leveraged Split Dollar Rollout
The Leveraged Split Dollar Rollout™ is a method to terminate an existing Loan Regime Split Dollar™ arrangement at a significant discount from the value of the collateral assignment interest. In the Loan Regime, the business is the lender, and receives a restricted collateral assignment interest in the life insurance policy's cash value and death benefit equal to the value of the loan plus any accrued interest. The collateral assignment interest is restricted until the earlier of the insured's death, termination of the Split Dollar arrangement or surrender of the underlying policy. The value of the collateral assignment note is potentially discounted due to this restriction. Since the business’s collateral interest is restricted for several years until the death of insured, there is a present value calculation to determine the current value.
At some point, the policyholder may decide to terminate the Split Dollar arrangement by purchasing the lender’s restricted collateral assignment interest in the policy. A valuation specialist values the note receivable for valuation purchases. The valuation specialist takes into consideration the life expectancy of the policy’s insured life as well as a discount rate. Due to the restriction, the receivable is likely to be discounted. Following the purchase of the Split Dollar receivable from the lender, the Split Dollar agreement is terminated. The policyholder may use a tax-free policy loan or withdrawal to purchase the note from the lender.
A decent amount has been written in the last several years about Intergenerational Split Dollar life insurance following recent Tax Court litigation in the Cahill, Morrisette, and Cahill cases which used Collateral Assignment Non-Equity Split Dollar and the Economic Benefit Method. These arrangements were private Split Dollar arrangements typically designed to transfer large amounts of value from the taxpayer’s estate at large discounts. I am personally aware of exceptionally large transactions having taken place at obscene (in a good way!) discounts.
Supreme Court Justice Potter Stewart in determining a threshold test for obscenity is famously known to have said, “ I shall not today attempt further to define the kinds of mate