Estate planning, a
moment fraught with the sort of long-term planning that gives rise
to insurance decisions, has always presented opportunities for life
insurers.
Now, adding an additional
opportunity for them to grab a bigger share at the high net worth
individual market is new US estate tax legislation.
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The new law forms part of the Tax
Relief, Unemployment Insurance Reauthorisation and Job Creation Act
of 2010.
Passed into law in December last
year, the new legislation came just in time to stop the top
marginal tax rate on estates valued at more than $1m returning to
55%.
Under terms of legislation
implemented in 2001 during George W Bush’s presidency, tax rates on
estates were phased down and stood at 0% in 2010. This tax-break
was due to expire in 2011.
However, while the 55% rate was not
reinstated under the new legislation, the federal estate tax
exemption for persons dying in 2011 and 2012 is now $5m with tax on
anything over that amount taxed at 35%. The exemption for couples
is $10m.
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By GlobalDataThe estate tax has long been the
cornerstone of marketing estate-related life insurance policies,
with the policies often held in trust arrangements to prevent the
policy proceeds from being included in an estate for tax
purposes.
The estate tax agreement
establishes the same levels as legislation introduced by senators
Jon Kyl, a Republican from Arizona, and Blanche Lincoln, a Democrat
from Arkansas, in the summer of 2010.
It is part of a wide-ranging tax
negotiation that includes the continuation of income tax cuts, a
one-year cut in the Social Security payroll tax and an extension of
unemployment benefits.
The estate tax changes and
continuation of tax cuts on all income levels add a level of
certainty to agents and brokers who are small business owners. And,
while the law is temporary which means uncertainty for families
trying to prepare their legacy should they live beyond the next two
years, it is a far better than the complete uncertainty that had
gripped financial planners for the last two years.
As a result, the planning
opportunities over the next two years have been increased
exponentially, as clients may use this window to take advantage of
life insurance, if they qualify, as a financial tool to deliver
cash to beneficiaries.
Meanwhile, provisions of the law
can help the very wealthy, in that it will motivate them “to take a
new look at their re-examine their estate plans over the next two
years and see how to use some of the new gifting laws and take
advantage of provisions that may not be in the final regulations”,
said Bob Kerzner, president and CEO of financial service
organisation the Life Insurance and Market Research Association,
Loma and LL Global.
The gift tax, or while-living
transfers, and the estate tax, or transfers at death, have been
unified at $5m per person. The old law said gift tax exemption was
$1m and the estate tax exemption was $3.5m.
This means life insurance could
become a hot-ticket financial instrument to leverage these new gift
tax exclusion amounts to acquire larger face amounts of life
insurance to benefit future generations.
Second-to-die policies and gifting
strategies employing life products make a lot of sense during this
two-year window. The gift tax exemption is not the annual gift tax
exclusion, which remains at $13,000 per year per person receiving
the gift.
To the extent a gift exceeds the
exclusion amount, the person making the gift has to start using his
or her lifetime gift tax exemption amount. This means that a $5m
lifetime gift can be made free of gift tax, free of estate tax and
grow permanently for the benefit of a client’s family members.
The law also introduces a new
option for married couples to defer estate taxes until the death of
the surviving spouse, called “portability”.
Portability permits the estate of a
surviving spouse to claim not only the surviving spouse’s estate
tax exemption, but also the unused estate tax exemption of the
predeceased spouse.
Before the change, the only way to
achieve this result was by creating a trust under the will of the
predeceased spouse. For reasons described below, spousal bypass
trusts have several advantages over the portability option. Bypass
trusts, therefore, will still be the recommended option in many
cases, notwithstanding the advent of portability.
There are many financial needs for
which life insurance can be part of a solution, and for people that
have no concern about estate taxes, some of that planning is going
to be easier.
Among those needs and uses for life
insurance are business succession planning and the leveraging of
certain assets like individual retirement accounts and 401(k) plans
to provide more to children and grandchildren.
Lifetime gifts offer several estate
tax advantages. To the extent a gifted asset appreciates in value
after the date of the gift, that appreciation in value is not
subject to estate tax as it would have been had the asset been
included in the donor’s estate.
Further, because Washington does
not have a separate gift tax, lifetime gifts reduce the Washington
estate tax due at death. Independent of the tax advantages, many
donors find lifetime giving to be gratifying.
And while estate tax rates might
remain historically lower and exclusion levels historically higher,
income tax rates and state death tax rates may go higher, which
would make a tax-free death benefit more valuable.
With repeal of the estate tax
altogether a possibility, depending entirely upon the political
fortunes of President Obama and his narrow Senate majority, few
life clients will be in a wait-and-see mood, particularly at the
higher end of the insurance market.
It is a two-year race, and it is
likely to be run at a fast pace.
Charles Davis
