We are frequently seeing a Single Premium Immediate Annuity as part of a Split-Dollar Loan proposal. This is bad and should stop. Split-dollar loan (SDL) remains a popular form of executive benefit, driven by more favorable financial impact on the credit union vs. other benefit forms as well as the potential for income-tax-free benefits for the executive.
The key under the income tax regulations is that each credit union payment must use the AFR for the month such payment is made. Once the payment is made, the AFR is locked in until the loan is repaid. Payment periods for the underlying life insurance policies are typically 7-10 years, which presents a modeling challenge to project—really, guess—what the AFR will be in future years (especially as we enter a rising rate environment). To eliminate this uncertainty, it is generally better to have all credit union payments pre-paid at inception.
To maintain favorable income tax treatment on policy distributions, however, all of the premiums cannot be put into the life insurance policy at once. Instead, the best practice is to use the insurance carrier’s “premium deposit account” or PDA. With a PDA, the insurer accepts advance premiums without commission and often even credits interest on the PDA balance. The best PDAs also have no surrender charges.
But what if your carrier doesn’t offer a PDA? Or has one with a surrender charge? Or limits the deposit in this low-rate environment? This is where we see the Single Premium Immediate Annuity or SPIA presented as a solution for premium pre-payments. The challenge is that —unlike the best PDA accounts—all of the SPIAs we’ve seen have surrender charges. This means one party (the credit union or the executive) suffers adverse accounting for this. The only party that wins—the broker who gets additional commission.
A better solution for when the desired PDA is not available from the carrier is to have the credit union hold the premium pre-payments --yes, a PDA at the credit union. There is no commission, there are no surrender charges creating accounting issues, and policy payments can be set up to be paid automatically from the account. These advantages outweigh any benefits that we see from using a SPIA.
To learn more about the nuances of split-dollar loan design, contact IZALE Financial Group today. Let us help you implement and service a program tailored for your objectives.