Insurance co. promotes arrangement to provide for first and second families. Janice Forgays is v.p. of Sun Life Financial's Advanced Markets Group. She is based in Wellesley, Mass.

Due to death or divorce, second marriages and new family structures are commonplace in today's society. Second families raise critical financial, inheritance, and estate planning considerations. There is often the desire to maintain the second family's standard of living while providing for the first family. A cash-value universal life insurance policy, using a traditional split-dollar arrangement, may provide a solution.

Split family, split dollar

Typically in a split family, the breadwinner's second family has the benefit of his or her earnings and investments. For that family, a support need is unlikely to arise until the breadwinner's death. Since the first family no longer has the immediate benefit of the breadwinner's earnings and investments, there is a void to be filled. A split-family, split-dollar arrangement can satisfy the desire to provide for both a first and second family.

The split-family, split-dollar concept uses one insurance policy insuring the breadwinner in a traditional non-equity collateral assignment split-dollar arrangement between the two families. The policy has two parts: cash value and death benefit. Under the split-family, split dollar plan, the current spouse owns the life insurance policy and retains the right to the pure insurance or death benefit portion of the policy to sustain the family upon the loss of the breadwinner. The spouse who owns the life insurance policy assigns the policy cash value to the first family. That way the first family gets access to the policy's values, filling the void caused by the loss of the immediate financial support of the breadwinner.

Certainly, when the desire is to provide for both a first and second family and there is the potential for conflict, life insurance owned by an irrevocable trust may be appropriate. A benefit of trust-owned insurance is asset protection for the policy. In addition, assuming the trust is properly established, the assets it holds will be protected from state elective share statues which allow the spouse to "elect against the will" and claim up to one third of the decedent's assets. Disadvantages of trust-owned life insurance include limited access to the assets held in the trust and the ongoing costs associated with the trust. A split-family, split-dollar arrangement can provide for both families without these disadvantages.

Due to the changing nature of family dynamics, certain protective actions for the arrangement may be desired. These may include the following.

The collateral assignment of the policy cash value to the first family may be made irrevocably so that it can not be removed or altered after the contract date.
If there are spendthrift concerns with the first family, the breadwinner may place a "restrictive endorsement" on the policy, which will allow the breadwinner to control activity related to the policy cash values. The endorsement does not give the breadwinner any beneficial interest in the policy, it ensures that the breadwinner is given notice of and has the opportunity to monitor the first family's activities related to the policy. No action can be taken (withdrawals, a pledge of the values, etc.) without the breadwinner's approval.
The policy on the breadwinner may be "split dollared" between an irrevocable trust and the first family. The irrevocable trust will be drafted for the benefit of the second family. It will own the policy and will collaterally assign the cash value of the policy to the first family. This eliminates the potential for the second spouse to revoke the policy or the split dollar agreement. Depending upon the dynamics within and between the two families, using an irrevocable trust for policy ownership may be warranted and worth the disadvantages noted above.

Tax Analysis

With a split-family, split-dollar arrangement, the policy premium is paid by the breadwinner. This does not constitute a gift or income to the current spouse, who owns the death benefit portion of the policy, under the unlimited marital deduction of Internal Revenue Service Code Section 2056. The premiums associated with the policy cash values owned by the first family may not be taxable if they fall within IRS Section 1041 and are "incident to divorce." It is also possible that the policy cash values may be used to satisfy income obligations ordered by a divorce court. Otherwise, the premiums may be deemed taxable gifts. In that case, they may be sheltered from gift tax using the gift tax annual exclusion and/or the breadwinner's lifetime exclusion equivalent. The policy should not be included in the breadwinner's taxable estate because the breadwinner is not a party to the arrangement; it is between the two spouses.

A split-family, split-dollar arrangement can be efficient from a planning perspective. If properly established, the parties will enjoy the benefits without income, gift or estate taxation. With one policy, the current family is provided for if the breadwinner dies. Needs of the first family are also provided for with the cash value of the same policy. A split-family, split-dollar arrangement may provide an effective and efficient tool to satisfy financial, legal and moral obligations. -FWR

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