Dealing with Potential Estate Tax Change from a Life Insurance Perspective

I rarely see someone pass up an excuse to not buy or to drop life insurance.  The talk about possible estate tax repeal is certainly one of those current excuses.  Life insurance is something most consumers feel is a need more than a want.  Without being forced into it by responsibility, a contractual obligation, etc, people are not generally lining up to buy it.  It is clearly something which is usually sold.  Rational people will differ regarding this as a reasonable perspective.

Generally speaking, I live in a death benefit world and work with high net worth owners of closely held businesses.  These people are the target market for life insurance sales to provide liquidity for business succession and estate tax liability.  Many take advantage of it but given an alternative, many wouldn’t.

What should these people be thinking today?  Move forward with current plans to purchase insurance?  Back burner everything to see what shakes out?  Drop what they currently have?  Let’s first understand that there are no answers to these questions on which there will be a significant level of agreement so I’ll simply share my thoughts.

Let’s start with those who have insurance.  No, don’t use this as an excuse to drop existing policies.  First of all, as of now, nothing has changed and there is serious disagreement on the chances of the tax going away.  Second, if the estate tax itself does change materially, there are other taxes which may very well be at play.

For years advisors have been bringing me in to give advice to policy owners who bought insurance for estate taxes but no longer have an estate tax liability due to the rising exemption.  This initiates a standalone analysis of the policy(ies) from a financial perspective.  We start by determining if the policy is doing what it is supposed to be doing and if it is a reasonable use of money on an IRR basis independent of any tax liability.  Many times the contracts are proven to be a good deployment of assets even if no taxes will be due and the policy settles in as a portion of a diversified estate portfolio.  After all, one dies with stuff and life insurance is just one pot of stuff.  Financially, intellectually & emotionally, what does it bring to the table?

It is difficult for me to understand how easily people will believe what they want to believe.  Few saw the election results coming and if it went the other way, we’d be talking about lower exemptions and higher taxes.  It begs the question, why are so many people willing to bet the farm on the fact there will not be a tax code with potentially debilitating consequences in effect 17, 26, 35 or 42 years from now?

I’ve read that the earliest taxes at death were from 700 BC in Egypt.  In the US they go back to 1797 and the modern estate tax just celebrated its 100th anniversary in 2016.  It’s like thinking in 1999 that the stock market was never again going to go down.  It’s like thinking gas will never again hit 4 bucks a gallon.  The list could go on.

A well-crafted, astutely managed life insurance portfolio can be a bright spot in an estate portfolio and the economic dynamics of it do not change whether or not there is an estate tax in effect at a given moment.  Your traditional investment performance doesn’t change due to an estate tax.  Your company performance doesn’t change due to an estate tax.

All that being said, we intellectually know consumers will still grasp at straws.  What are some ideas to counter their sometimes self-destructive tendencies?   Talking about the likelihood of tax change is probably not going to sway them.  As an insurance professional I am particularly tuned in to insurability.  Regardless of what anyone might say about that being a scare tactic, it is not.  In my market this is an issue which torpedoes potential planning solutions regularly.  Salvaging insurability for an individual who is otherwise willing to leave him or herself twisting in the wind between now and the inevitable next change is important.

There is a great way to do this for a portion of the market and it is through term insurance.  I wouldn’t lead with it but I would certainly bring it up to keep someone from walking out the door naked.  Term rates are cheaper than most people think and sometimes ridiculously so.  I’ve had advisors ask me for rates and when I give them an annual premium they think I have quoted monthly.  Convertibility features of various products is important and convertibility to age 75 is available in some contracts.  Remember that with the right products and carrier, individual term policies on each spouse can be convertible to a second-to-die policy as well.  There is a lot more at play here than most people realize so be sure to seek out an expert.  For the love of goodness, please don’t view term as a commodity.

A potential downside is that pricing for permanent products has been on an upward trend for a half dozen years now and product availability is much different now than it was not long ago.  While one can preserve insurability with term insurance, pricing and products available for conversion in the future still poses a risk.  A potential solution to that as well as for individuals where an age 70 or 75 deadline doesn’t make sense because they are already almost that age or have exceeded it, “underfunding” a flexible premium product can produce similar results and take the pricing and availability unknowns off the table.

There are even a few carriers with second-to-die term insurance options.  Personally, I have always maintained a significant amount of term insurance on my life, as well as on my wife’s, for future convertibility to single life or survivor life coverage for tax or charitable purposes.

Keep in the back of your mind that for those who are insistent on bailing on existing policies, an astute advisor should never let a client do so before recommending an independent evaluation.  For some, a life settlement will bring more to the table than surrendering a policy.  For every policy owner, their contract is in either a gain or a loss position.  If it is in a gain position, they need to understand the tax implications.  If it is in a loss position, though not generally deductible, there are very effective ways to salvage the loss, shelter future gain or take a future loss and it would be a shame to throw that out the window.

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