From niche product optimization aimed at boosting internal rate of return (IRR) to leveraging split dollar arrangements for effective employee retention and minimizing gifting taxes through private financing, these strategies offer new avenues for financial advisors to drive client success and differentiate their services in a competitive market. 

Watch our webinar for an in-depth look at each of these strategies, including detailed case studies.

#1 Boosting internal rate of return (IRR) with niche optimization

What is IRR?

IRR represents what an alternative investment would have to yield annually to produce the same benefit provided by life insurance. IRR is often the best way to compare various investment vehicles, sometimes with different funding patterns, to determine the best option for clients.

Many life insurance policies, especially products with secondary guarantees–like GUL products—are non-correlated assets that don’t always move in conjunction with traditional financial markets like stocks or mutual funds. This lack of correlation means that the asset's performance is independent of broader market movements, which can be attractive for clients looking for a stable investment. 

Also, it’s essential for advisors to keep in mind that, in life insurance, IRR represents a net value, and advisors should use the pre-tax equivalent to compare life insurance to an alternative investment accurately. 

Case study: Product niche optimization yields nearly 20% IRR

The illustration below compares two solutions from different carriers for a 68-year-old male client who is in good health and has nonsmoker rates.

In this scenario, we’ll focus on Carrier A. The client initially needed a $10 million death benefit that may increase as the estate grows. We selected a return of premium (ROP) option that increases proportionally to the premiums paid into the policy. This allows the client to pay a minimum premium for the first five years, in this case, about $286,000.

Carrier A does not place a heavy emphasis on the time value of money in the policy. This particular product generally performs the same whether you front-load it with a lump sum or spread out the premium over the first few years. However, the more we can spread out the premium, the better the IRR. Additionally, the client can skip the premium from years five to 16 and catch up in five-year increments. While the catch-up premium payments can be significant when looking at normal life expectancy rates, the net IRR of this strategy is about 11.4%, and the gross IRR in a 40% tax bracket would be about 19%.

Few alternative investments can match this IRR, which can be a great selling point for clients reluctant to use life insurance as a wealth accumulation tool.

How else does Modern Life help advisors boost IRR?

There are three additional ways we can help clients boost IRR:

• Tiered premium approach: Similar to the skip design discussed above, a tiered premium can increase IRR by starting with lower initial premiums and gradually increasing them over time. This strategy allows more flexibility early on and optimizes cash flow timing, contributing to a potentially higher IRR.
• Return of death benefit option: This approach uses single-pay or short-pay options. In this approach, we use a lower death benefit with an ROP for one year and then level it off to help lower the policy's initial cost of insurance (COI). For example, if we have a $500,000 1035 exchange for a 5M policy, we can use a 4.5M death benefit with an ROP instead. This approach immediately gives the client the full 5M coverage they want, which can help increase the IRR. 
• Utilize a 1035 exchange for a SPIA: We can use a 1035 exchange from the current life policy into a Single Premium Immediate Annuity (SPIA) and then use the net income to fund the new life policy. This works well if the client has a high-cost basis in their current policy, which usually leads to a high exclusion ratio on the SPIA and, therefore, less of a tax burden.  

#2 Employee retention with split dollar arrangements

The Federal Trade Commission’s recent ruling to ban non-compete agreements highlights the difficulty some companies may soon face in retaining key employees in this competitive labor market. Deferred compensation plans can offer an alternative. However, these arrangements usually have significant administrative costs and strict compliance requirements with IRC 409A–a set of rigorous reporting rules that businesses must handle in traditional deferred compensation scenarios. A better option for business clients can be a split dollar arrangement. 

What is a split dollar arrangement?

For a business using a split dollar arrangement, the value of the life insurance policy is divided between the company and the employee. Two types of split dollar arrangements can be used: the economic benefit regime (also known as endorsement split dollar) and loan regime. The main difference is who owns the policy. With economic benefit, the employer owns the policy, and with loan regime, the employee owns the policy. 

In this instance, we will focus on the more common arrangement– endorsement split dollar. The split dollar arrangement acts as key person coverage for the employee, but it is owned and paid for by the business. A portion of the death benefit is endorsed to the employee, and in return, the employee pays tax based on the endorsed portion. The tax is based on either IRS Table 2001 or, if available, the carrier’s alternative term rates. 

The benefits of split dollar arrangements

• 409A avoidance: There is a short-term deferral exception to 409A. If the policy is distributed within two and a half months of the end of the calendar year when the employee satisfies their service obligation, 409A reporting can be bypassed.
• Minimal administrative costs: In endorsement split dollar arrangements, the administrative costs can be relatively low compared to other, more complex employee benefit plans. 
• Carrier choice: The client can use any carrier to optimize for costs. Additionally, some carriers handle the administration for free or reduced costs.

Utilizing permanent coverage

Some advisors might consider using a term policy as the key person coverage because these products can be cheaper and easier to implement than permanent policies. However, cost recovery is rarely achieved with term policies because the vast majority of term policies never pay out.  

However, if a permanent policy is used, the business has access to the cash value, which is also a corporate asset and shows up on the balance sheet. In addition, tax-free Long Term Care Riders can be added to make the arrangement even more attractive for the employee.

Structure of economic benefit split dollar arrangements

This flowchart shows the basic structure of an economic benefit split dollar arrangement.

While premium payments are not tax deductible, the business can access the policy’s cash value. The company can choose any amount of the death benefit to be endorsed to the employee. However, the company must retain the greater of the premiums paid into the policy or the cash value. 

As mentioned above, the employee is responsible for the economic benefit charge based on IRS Table 2001, or for some carriers, it’s based on their alternative term rates.

After the employee has fulfilled the service requirement (usually a term like ten years or retirement age), the policy is transferred to the employee. The employee must pay tax on the policy's fair market value, usually paid by withdrawing from the life insurance policy. Consequently, the business also gets a corresponding tax deduction based on the same fair market value. 

How does Modern Life help advisors with split dollar arrangements?

Modern Life can provide advisors access to several third-party administrators, presentations, and sample documents such as split dollar or key person agreements. 

#3 Minimize gifting taxes while boosting estate planning flexibility with private financing 

Given the estate tax sunset planned for 2026, high-net-worth individuals may feel unsure of the estate tax landscape. 

Instead of gifting away assets to mitigate estate taxes, clients can instead incorporate those assets into a private financing arrangement. This arrangement is similar to a corporate split dollar scenario we discussed above, except it’s typically between a grantor and an irrevocable life insurance trust (ILIT).

The grantor makes a series of loans to the ILIT to pay the policy premium, and the trust pays the loan interest to the grantor.

IRS Rule 85-13 states that you cannot create a taxable transaction with yourself. Therefore, a grantor and the trust are the same for income tax purposes. This means the loan interest is tax-free income for the grantor.

Loan interest is based on the applicable federal rate (AFR), which the IRS releases on a monthly basis. There are three AFR categories:

• Short-term AFR is any loan that matures between zero and three years
• Mid-term AFR is any loan that matures between three to nine years
• Long-term AFR is any loan that matures over nine year

Estate planning flexibility

A private financing plan provides flexibility and gift tax mitigation for clients. The very nature of the arrangement itself means that the grantor still has access to the trust assets through the outstanding note they otherwise would not have access to if simply making a gift to the trust.

Gift tax mitigation

One of the main advantages of private financing is gift tax mitigation. Instead of making an outright gift to the trust for the entire premium, the client can loan the money to the ILIT, and therefore, the gift becomes the loan interest versus the premium itself. For example, the premium payment might be $100,000. Instead of making a gift of $100,000, the client can loan it to the trust. If we assume an AFR of 4.5%, the gift to the trust essentially becomes $4,500 (this assumes the trust doesn’t already have the necessary funds to pay the loan interest).  

The benefits of private financing over third-party lenders

Private financing arrangements can provide many benefits to clients over third-party lenders, including:

• Current interest rates are high, making third-party lending an expensive option. By contrast, AFR is generally more manageable and predictable.
• No collateral is necessary since the policy acts as collateral. 
• The loan can be repaid during life or death, but with third-party financing, the lenders usually want to be repaid during life.
• There is no risk of the loan being called since the grantor is the lender.
• Payback of the loan stays within the estate rather than being lost to the third-party lender.
• The client has the option to accrue interest at any point. While it’s ideal to pay the interest on a steady, ongoing basis, it’s still an option that does not always exist with third-party financing.
• There are no restrictions on the type of product that can be used.
• The client retains access to the trust’s assets.

Next steps

The life insurance market is continually evolving, and embracing innovative sales strategies is essential for advisors aiming to deliver exceptional value to their clients. By staying informed about emerging trends and adopting innovative approaches, financial advisors can position themselves as trusted partners who not only navigate financial and estate planning complexities but also unlock new opportunities for their clients. 

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