Life Insurance: Still Good for Estate Planning

The American estate tax turned 100 this year. It probably won’t live to see 101.”

That’s the lead sentence in a December 9, 2016, Wall Street Journal article commenting on the likelihood the incoming administration will introduce legislation to repeal the estate tax. But while it’s a nifty turn of the phrase, and might be an interesting topic for debate (“Should the government tax someone again after they’re dead?”), the estate tax is really a non-issue for most American households.

  The Tax Policy Center estimates that only 0.2% of Americans who die in 2017 will leave an estate large enough to incur federal estate taxes. That’s roughly 5,200 people, a number so small that the impact of the current estate tax on government revenues and social inequality is already miniscule.

However, depending on what might be repealed, there could be new tax regulations regarding the transfer of assets at death, and these might apply to a broader segment of the populace. Thus, permanent life insurance – i.e., life insurance intended to be in force for one’s lifetime – is still one of the best estate planning solutions for the unknowns and uncertainties that come with generational asset transfers.

Guaranteed Money, Precisely When Needed

The essential advantage of life insurance in estate planning is the guaranteed liquidity it provides for a future event (death), whenever it happens. In the past, large estates may have earmarked the proceeds from an insurance benefit to pay taxes, ensuring that other, more valued assets (such as homes or businesses) did not have to be sold to satisfy the bill. But apart from federal estate taxes, a permanent life insurance program can be used in a variety of ways to optimize the transfer of valuable assets to future generations. For example, permanent life insurance can…

  • Protect and preserve the most valuable assets. A family home with a mortgage becomes an obligation of the estate at the death of the owner. Similarly, outstanding business and personal loans must be settled. From a balance sheet perspective, an estate may have enough assets to meet these monthly obligations or make a payoff. But liquidation of these other assets may occur at inopportune times, or require the estate to accept discounted valuations. Life insurance is an economically efficient strategy to provide instant liquidity precisely when needed, and allow valuable assets to remain in the estate or be liquidated for full value.
  • Provide equitable treatment for heirs with disparate interests. Because of circumstances, some heirs may not value estate assets, like real property or ownership of a business, in the same way. An heir may prefer to sell his percentage of ownership rather than continue as a partner with other beneficiaries. In these situations, the disinterested heir can force a sale or compel other beneficiaries to borrow against estate assets to receive his share. The immediate liquidity from a life insurance benefit can eliminate these costly options, while providing equitable treatment for those who want out.​
  • Serve as an escrow account for other estate-related taxes. The elimination of the federal estate tax does not affect the levies states may charge. As of 2016, fifteen states have estate taxes and six impose inheritance taxes, with the top brackets taking a 20 percent cut of assets over specific thresholds.

In addition, the repeal of the federal estate tax may give rise to higher capital gains taxes. One of the unique features in current estate tax law is the “step-up” in basis that heirs receive when inheriting financial assets. This means a beneficiary’s basis for tax purposes is the value on the date of transfer, not the original purchase price.

Some proposals concurrent with the elimination of the estate tax eliminate this step-up, meaning that a beneficiary could incur significant capital gains taxes when liquidating an asset from the estate. A 15 or 20 percent tax on capital gains calculated on the original share price could be just as substantial as an estate tax assessment.

To add to the complexity, tax laws change frequently. Life insurance is a “pop-up” escrow account for these taxes, whatever they may be.

2017-33568 Exp. 1/2019

Posted in Estate Planning