Private Split Dollar as a Buy-Sell Premium Payment Strategy

Situation: Financial advisor called DBS concerning a situation involving a family business where only one of the owner’s three adult children was involved in the business. As is typical with business owners, a significant portion of the owner’s estate was the value of the business. The advisor was struggling with how to provide an “equal” estate division between the child involved in the business and those who were not. The advisor was aware that the business heir could acquire insurance on the parent(s) so that funds would be available to help the heir buy-out the siblings’ interest. The advisor was concerned with the business heir being able to afford the coverage cost because the owner was not in “great health.”

Problem: It is not unusual for business owners to delay planning for the continuation of their business. They are always busy working in their business and need to be reminded of the importance of working on their business. An owner’s change in health can be a wake-up call. If coverage is available, the issue becomes how to structure the life insurance premium payments so that the business heir can afford the payments.

Solution: When the issue becomes how to structure the life insurance premium payments so that the business heir(s) can afford the payments financial professionals are quick to suggest that the parent(s) can make gifts to the business heirs. Such a solution is simple but may meet with resistance because it does not treat the other heirs equally. It may be possible to bonus the heir additional compensation, but this may also meet with resistance. One way to overcome this objection is to suggest the parent(s) use private financing as a way to pay the life insurance premiums.

Private financing, also known as self-financing or private split dollar, is the funding of life insurance premiums through a personal loan. . . in this case a loan between the parent(s) and the business heir. Unlike premium financing which involves a third-party lender, with private financing the parents act as the lender; there is no need for loan origination fees, collateral deposits, or significant increases in premiums to account for the required loan repayment. The private financing technique can be an attractive alternative to paying life insurance premiums. Following is how private financing works:

  • Parents and business heir(s) enter into a loan agreement and buy-sell agreement.
  • Parents(s) loan an amount equal to premiums for a life insurance policy on the parent/business owner’s life.
  • The business heir(s) pay loan interest based on the appropriate Applicable Federal Rate (AFR). Annually the parents report the interest as income.
  • Usually, the loan is repaid at the death of the insured out of the insurance proceeds, although the loan may be repaid earlier.
  • The loan amount repaid to the parent’s estate is divided between the heirs according to the terms of the parent’s estate plan.
  • After repaying any loan amount outstanding to the parent’s estate, the balance is paid to the business heir(s) to help buy-out the business interest inherited by the non-business heirs.

Unlike the gift of premium payment, with the private financing strategy the loan repayment ultimately restores the parent’s premium advances so that this amount can be distributed “equally” as part of the parent’s estate plan.

How DBS Can Help

To learn more about how private financing can be used to help achieve the goals of your clients, call Terri Getman, JD,* CLU, ChFC, RICP, AEP (Distinguished), DBS’s advanced sales resource.

*Not in the practice of law.