Abstract:
A method of providing supplemental funding of an life insurance policy through a split-dollar loan arrangement. An employer loans an employee additional premiums to increase the values of the life insurance policy. To replace working capital or retained earnings diminished by the loan to the employee, the employer borrows from an outside lender securing the loan with the assignment it holds on the life insurance policy.

Description:
BACKGROUND OF THE INVENTION  
       [0001]     The present invention relates to mechanisms for funding life insurance policies, and more particularly to mechanisms for supplemental funding of life insurance policies. The present invention also relates to mechanisms that enable a company to replace, for example, working capital, and or, retained earnings when the company lends money to an employee to be used as, for example, additional premium to increase the values in a life insurance policy purchased by the employee.  
       SUMMARY OF THE INVENTION  
       [0002]     In an exemplary embodiment, the present invention provides a method of supplemental funding of an insurance policy wherein a loan to an employee of a company is secured by a collateral interest in a life insurance policy owned by the employee. To replace working capital, or retained earnings that have been diminished by the loan to the employee, the company borrows from an outside lender. As security for this loan, the company can re-assign its collateral interest in the life insurance policy, along with, if desired, assets of the company. In accordance with an embodiment of the present invention, the life insurance policy and the loan arrangements are structured to comply with IRS Tax Codes and U.S. Treasury Regulations. The loan(s) made by the company to the employee as additional premium significantly increase the values of the life insurance policy for the benefit of the employee.  
         [0003]     In an exemplary embodiment, the present invention also provides a method of supplemental funding of an insurance policy that is owned by a first entity. Such a first entity can be, for example, an employee, a trust, a family member of the employee, a contractor, a director, or, an outside entity that receives compensation from the company. In this exemplary embodiment, the policy has base premiums that are owed to issue and maintain the policy. The insurance contract also allows for the payment of optional additional premiums for additional benefits under the insurance policy. The exemplary method includes, for example, providing a loan agreement from the employer (which can be, for example, a C or S corporation, a partnership, an LLC or a LLP) to the employee for payment of the additional premiums; receiving an interest in the insurance policy from the employee as security for the loan agreement; and paying the additional premiums under the loan agreement. 
     
    
     BRIEF DESCRIPTION OF THE DRAWINGS  
       [0004]      FIG. 1  schematically illustrates an example of a capital split-dollar insurance arrangement in accordance with an aspect of the present invention. 
     
    
     DETAILED DESCRIPTION OF THE PREFERRED EMBODIMENTS  
       [0005]     Referring to  FIG. 1 , an employee obtains an insurance policy  20  covering, for example, the employee&#39;s own life. The policy  20  can be any of a variety of types, including a universal life insurance policy or a whole life policy. Such policies typically require annual payments of base premiums  30 , and provide for benefits  15 , such as for example, a death benefit and cash values. The policy  20  also allows the payment of additional premiums  40 .  
         [0006]     As shown in the exemplary embodiment of  FIG. 1 , the additional premiums  40  can be paid by an employer  50 , or directly from an outside lender to the issuer of the policy  20  on behalf of the employee  10 . The number of additional premiums  40  that can be paid depends upon the terms of the policy  20 . One non-limiting example number of additional premiums  40  is three additional premiums. The number can be set to any suitable number as agreed under the policy. In the illustrative embodiment, the additional premiums  40  can be used under the terms of the policy  20  to purchase additional death benefit to be added to the policy  20 . The employer  50  can provide the funds for the additional premiums  40  to the employee  10  who subsequently pays the additional premiums.  
         [0007]     Paying additional premiums  40  can significantly increase both the cash value of the policy  20  and its death benefit over the amounts that would be provided by the payment of the base premiums  30  alone. Paying the addition premiums  40  typically increases the cash value and death benefit of the policy  20  by amounts that are generally greater than the death benefit and cash values that the issuing insurance carrier would offer under a separate permanent policy on the employee&#39;s life for the payment of an amount of premiums equal to the additional premiums  40 .  
         [0008]     In accordance with an example embodiment of the present invention, the policy  20  is issued to and owned by the employee  10 ; and the employee  10  is solely responsible for and pays the base premiums  30  as they become due. The employee  10  may enter into an arrangement with the employer  50  whereby the employer  50  will deduct the base premiums  30  from the compensation that would otherwise be payable to the employee  10  and pay that amount directly to the insurance carrier on his behalf as, for example, the employee&#39;s agent. If, in such an arrangement, the employer  50  pays the base premiums  30 , the employee would report the amounts paid to the carrier on his behalf as ordinary income. In any event, the employee pays the base premiums  30 , either directly or through the arrangement with the employer  50  such as just described, for an initial period, such as for at least the first seven years that the policy  20  is in force.  
         [0009]     In accordance with one aspect of an embodiment of the present invention, the employer  50  and the employee  10  can enter into a split-dollar interest-free, or interest bearing loan agreement  60  (“split-dollar agreement  60 ”) and a collateral assignment  70 . Under the split-dollar agreement  60 , the employer  50  can pay the additional premiums  40  to the insurance carrier on behalf of the employee  10 , or arrange for the outside lender to pay the additional premiums  40  directly to the insurance company. As summarized above, the additional premiums  40  result in increasing the death benefit and cash value of the policy  20 . Each additional premiums  40  payment made by the employer  50  to the insurance company is, in accordance with this embodiment of the invention, treated as either an interest-free, or interest bearing loan to the employee  10 . The split-dollar agreement  60  can provide that the cumulative amounts loaned as additional premium to the employee  10  (“repayment amount”) is to be repaid to the employer  50  from the proceeds of the policy  20  in the event of the death of the employee  10 , or from the cash value of the policy  20  if the arrangement with the employee  10  is otherwise terminated.  
         [0010]     Furthermore, the split-dollar agreement  60  will provide that, so long as the arrangement with the employee  10  remains in effect, the employee  10  may not withdraw funds from the cash value or borrow from the policy  20 . Additionally, the employee  10  should not borrow from the policy  20  before the end of the seventh year the policy  20  has been in effect, even if the arrangement with the employer has been terminated.  
         [0011]     In accordance with another aspect of a preferred embodiment the repayment amount is secured by a security interest in the policy  20  to the employer  50  by the collateral assignment  70 . The collateral assignment  70  can provide, as can the split-dollar agreement  60 , that the repayment amount will first be paid to the employer  50  from the proceeds of the policy  20  in the event of the employee  10 &#39;s death, or from the cash surrender value in the event the arrangement with the employee  10  is terminated for some other reason prior to the death of the employee  10 . It is envisioned by the preferred embodiments that the collateral assignment  70  only creates a lien or security interest in favor of the employer  50  and does not result in a transfer of an ownership interest in the policy  20  (or any part thereof) to the employer  50  As a result, the employer  50  does not have incidents of ownership in the policy  20 , such as, without limitation: a right to withdraw the cash surrender value; a right to borrow on the policy  20 ; or a right to designate beneficiaries of the proceeds as a result of the collateral assignment  70 .  
         [0012]     In accordance with the preferred embodiments, the split-dollar agreement  60  and the collateral assignment  70  remain in effect until, after the termination of the arrangement with the employee  10 , the obligation to the employer  50  under the split-dollar agreement  60  and the collateral assignment  70 , e.g., payment of the repayment amount, has been satisfied in full.  
         [0013]     One example of a mechanism for funding the payment of the additional premiums  40 , the employer  50  can borrow an amount via a loan  80  from a third party, such as an outside lender  90 . One non-limiting example of an outside lender  90  is the insurance carrier that issued the policy  20  as collateral. The loan  80  can have any desired form. For example, the loan  80  can be evidenced by one or more negotiable promissory notes  100  with a fixed term of repayment having a rate of interest and other terms which could be obtained from any independent third-party commercial lender. In particular: it is anticipated that in accordance with an embodiment of the present invention, the loan  80  can be a full recourse obligation of the employer  50 ; it is preferably not a policy loan; the loan would be subject to the outside lender&#39;s determination of the employer&#39;s credit worthiness; and the terms of repayment will be independent of the terms of the arrangements with the employee  10 , the split-dollar agreement  60  and the collateral assignment  70 . As is common, the promissory note or notes  100  may allow the prepayment of principal and interest.  
         [0014]     To secure the loan  80 , the employer  50  can assign to the outside lender  90  all of the rights of the employer  50  under the collateral assignment  70  via a reassignment  110 . However, it is preferable that neither the terms of the loan  80  nor the reassignment  110  condition the obligation of the employer  50  to pay the loan  80 . For example, it is preferred that neither the loan  80  nor the reassignment  110  condition the employer&#39;s obligation on any event which, under the terms of the arrangements with the employee  10 , the split-dollar agreement  60  or the collateral assignment  70 , would result in repayment to the employer  50  of the repayment amount or would enable the employer  50  to exercise its rights to the collateral under the collateral assignment  70 . The rights of the outside lender  90  under the reassignment  110  should, in accordance with a preferred embodiment, be superior to those of the employer  50  under the collateral assignment  70 , but the outside lender  90  should not obtain greater rights under the reassignment  110  than the employer  50  has under the collateral assignment  70 .  
         [0015]     The arrangements with the employee  10  can, in accordance with a preferred embodiment, terminate on the death of the employee  10 , the termination of the employee&#39;s employment with the employer  50 , after notice to terminate given by either the employee  10  or the employer  50 , the surrender of the policy  20  by the employee  10  or the failure of the employee  10  to pay one of the base premiums  30 . In the event of the employee&#39;s death, the policy  20  proceeds can be, to the extent of the repayment amount, used to repay any remaining unpaid balance of the loan  80  to the outside lender  90 , as a repayment of the amount owed by the employee  10  to the employer  50  under the split-dollar agreement  60 . If the repayment amount is greater than the unpaid balance of the loan  80 , that excess can be repaid to the employer  50 . Thereafter, the remaining proceeds will be paid to the employee  10 &#39;s designated beneficiary. If the repayment amount is less than the amount owing on the loan  80 , the employer  50  will be responsible for the payment of any deficiency.  
         [0016]     If the arrangements with the employee  10  terminate for some reason other than the death of the employee  10 , the employer  50  can use the repayment amount to repay any remaining unpaid balance of the loan  80  to the outside lender  90 , and any excess of the repayment amount over that balance will be retained by the employer  50 . Repayment of the loan  80  and/or the repayment amount may be funded with a withdrawal from the cash value of the policy  20  or, if the policy  20  has been in effect for at least a minimum period such as seven years, a policy loan on the policy  20 . The outside lender&#39;s lien and the employer&#39;s subordinate lien against the policy  20  would then be released.  
         [0017]     The following outlines an embodiment of the present invention in which the employer  50  is a corporation duly organized, existing and in good standing under the laws of the state of its incorporation. In this example, it is assumed that the employer  50  is a domestic corporation within the meaning of § 7701(a)(4) of the Internal Revenue code of 1986, as amended (“IRC”); it may be taxed as either a “C corporation” within the meaning of IRC § 1361(a)(2) or an “S corporation” within the meaning of IRC § 1361(a)(1). Under such circumstances, it is contemplated that if the employer  50  is an S corporation:  
         [0018]     1. For all taxable years during which the arrangements with the employee  10  are in effect, the employer  50  will be an S corporation within the meaning of IRC § 1361(a)(1) for the entire year;  
         [0019]     2. At all times during which the arrangements with the employee  10  are in effect, all activity in which the employer  50  is involved constitutes an active trade or business and not a passive activity within the meaning of IRC § 469; and  
         [0020]      3 . At all times during which the arrangements with the employee  10  are in effect, the S corporation does not engage in any activities that are not engaged in for profit.  
         [0021]     As will be understood by those skilled in the art, the interest amounts attributable to the interest free loan that are foregone by the employer  50  will be accounted for in accordance with IRC § 7872 and Treas. Reg. § 1.7872-15, and any other taxable benefits provided by the arrangements with the employee  10  will be included in the employee&#39;s compensation and reported by the employer  50  on applicable withholding statements. The employer  50  should normally withhold all applicable amounts to the extent necessary. Also, it is understood that all compensation paid by the employer  50  to the employee  10 , including the foregone interest amounts and any premiums  30  paid by the employer  50  as compensation to the employee  10 , will be reasonable. As an additional consideration, it is desirable that the policy  20  not be classified as a single premium policy under IRC § 264(a)(2) and (b). Accordingly, the sum of the base premiums  30  and the additional premiums  40  paid during the first four years that the policy  20  is in effect should not exceed 65% of the total anticipated premium payments due under the policy  20  during the maximum life of the policy. In addition, it is preferable that no more than 3 years of additional premiums  40  will be borrowed in the first 7 policy years so that the policy will comply with the “safe harbor” provision known as the “4-out-of-7 rule” as contained in IRC § 264(d)(1). The policy  20  should preferably qualify as a “life insurance contract” under IRC § 7702, and not either a modified endowment contract as defined under IRC § 7702A, or any part of any group-term life insurance plan described in IRC § 79.