In the realm of financial planning, the incorporation of life insurance into legacy planning strategies has emerged as a powerful tool for creating liquidity and safeguarding wealth. Particularly, life insurance held within an Irrevocable Life Insurance Trust (ILIT) offers a compelling avenue to achieve these objectives. The allure of life insurance lies in its favorable tax attributes, providing a shield against estate and income taxation when structured effectively.

However, navigating the complexities of legacy planning, especially in anticipation of impending changes such as the sunset of the increased Basic Exclusion Amount for estate tax purposes, can pose significant challenges. Clients often find themselves grappling with uncertainties regarding the optimal coverage needed and the timing of funding a policy.

In this white paper we'll use a client example to provide practical advice for those in similar positions ;and explore various strategies and flexible planning with life insurance.

Case Study

Our clients, Bill and Linda, are in their late 50s and early 50s, living in Virginia with their four grown kids. They've got a hefty $31 million estate, mostly thanks to Bill's business valued at around $23 million. Bill's hoping to sell his business in the next five years for $40 million. They want to make sure their children receive the majority of their wealth, but they're also realistic about setting aside some cash for taxes.

Considering their age and good health, they are considering the purchase of life insurance, using a thoughtful approach to ensure they're not overspending on premiums, and keeping things in line with what they'll owe in taxes.

Strategy #1: Leverage The Conversion Privilege Of Term Life Insurance For Future Estate Planning

Before selling the business, it's important to ensure Linda has additional financial support if something were to happen to Bill. Term insurance offers a solution, as it can typically be converted to permanent life insurance without requiring further proof of insurability during a specific conversion period.

However, converting term insurance to a permanent single life policy may not be the most cost-effective option compared to a policy that pays out the death benefit upon the death of the second of two insured individuals. Second-to-die life insurance is commonly used in estate planning because estate taxes are often deferred until the second death in a married couple.

Fortunately, some insurers allow two separate term insurance policies to be converted into a second-to-die policy.

To address their needs, Bill and Linda each establish an irrevocable trust to purchase a $5 million 10-year level premium term life insurance policy on their own lives. Both have been approved for preferred nonsmoker rates. Their plan is to maintain this coverage as term insurance for five years.

After 5 years, Bill and Linda can reassess the need for coverage. If it aligns with their long-term plan and they're prepared to finance the policy, the term policies can be transferred from the ILITs to a Dynasty trust. The Dynasty trust then has the flexibility to convert any portion of the term insurance to second-to-die coverage, depending on their preferences. Permanent life insurance can be funded over the insureds 'lifetimes or for a shorter duration, but they decide that a five-year funding period with coverage lasting their lifetimes is most suitable.

In total, $1.44 million in premiums were paid to secure $10 million in coverage, with minimal upfront costs in the initial years of the policy. While having single life coverage in the early years may seem appealing, it's important to recognize that the ability to convert term insurance to second-to-die coverages not universally guaranteed in contracts, and the eligibility criteria for this strategy may vary among insurers.

Strategy #2: Customize The Funding Of Universal Life Insurance

Some clients feel uneasy about the possibility of insurers altering their rules regarding the conversion of term insurance to second-to-die coverage or making changes to their products overall. For these clients, Universal Life products offer customizable funding options tailored to their specific needs.

Universal life insurances characterized by its flexible premiums. While its uncommon, clients have the option to vary their premium from year to year. Policy owners can start with minimum premiums and increase them as needed to cover the cost of insurance and maintain coverage. They also have the flexibility to overfund the policy in one year and skip premium payments for several years. By paying more than the cost of insurance, any excess can accumulate interest in the policy's cash value. This cash value serves as an asset to the policy owner, offering cost recovery while the insured individuals are alive.

For Bill and Linda, opting for a step-pay approach didn't significantly differ in initial cost from term insurance but provided greater certainty regarding the long-term cost of coverage. The ability to skip premium payments was appealing from an

administrative standpoint. With ample resources available, they could easily afford the $128k initial premium without affecting their plans for annual exemption gifts to their children. This allowed them to focus on their business for the next five years without worrying much about the policy. While the short-pay option seemed attractive in terms of cost recovery, they weren't prepared to make such a significant outlay until after selling the business.

strategy #2: Split dollar

For clients like Bill and Linda, split dollar life insurance presents a compelling avenue for optimizing wealth transfer while minimizing tax liabilities. By way of background, split dollar is an agreement to share a life insurance policy between two parties: typically, an employer and an employee or between an individual and a trust.  It's a way for both parties to share the costs and benefits of the policy. Further, it allows the party with cash to offer coverage to the less liquid party with minimal expense.

In a typical split-dollar arrangement, one party pays the premiums on the life insurance policy, while the other party receives some of the death benefit proceeds. The parties enter into a legal agreement that outlines how the premiums, cash values, and death benefits will be split between them. There are generally two types of split-dollar arrangements:

1. Economic Benefit Regime: In this type, the premium Payor is the deemed owner for tax purposes. The premium payor is owed the cash value of the policy at the insured’s death or termination of the split dollar agreement.  The other party to the agreement receives the bulk of the death benefit and owes tax on the one-year cost of the life insurance each year.  

2. Loan Regime: Here, the owner assigns a portion of the policy's death benefit to the premium payor/lender as collateral for a loan.  The policy owner must pay or accrue interest due to the premium payor using at minimum the Applicable Federal Rate.  Upon the insured's death, the loan amount plus interest is repaid to the collateral assignee, and the remaining death benefit goes to the policy beneficiaries.

For some clients it may be beneficial to start with an Economic Benefit Regime agreement and switch to a Loan Regime split dollar in later years

By structuring the policy within a split dollar arrangement, Bill and Linda can strategically allocate premium payments and death benefits to achieve their estate planning objectives. This flexibility provides Bill and Linda with the ability to adjust their funding approach as needed, whether in response to changes in their financial situation or evolving tax regulations. Further, the life insurance policy within a split dollar arrangement enables Bill and Linda to facilitate wealth transfer to their children in a tax-efficient manner. By strategically designating beneficiaries and ownership interests, they can minimize estate taxes and maximize the value of the policy for their heirs.


The anticipated sunset of the Basic Exclusion Amount at the end of 2025 creates a great deal of uncertainty for clients who have or are on the edge of having a taxable estate. Practitioners have been using life insurance in trust as a tool to tax efficiently pass wealth for generations, but conventional life insurance funding strategies may not appeal to clients who aren’t certain that life insurance fits into their long-term plans.  The flexibility of life insurance can give clients the ability to customize policy funding to fit their objectives.


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