By John S. Budihas
With the reduction of the estate tax and its one-year repeal on the horizon, many people thought they would soon be saying goodbye to liquidity planning with life insurance for preserving assets and creating legacies.
After all, the highest estate tax marginal tax will reduce to 45% in 2007 from 55% in 2001. The lifetime exclusion equivalent increases to $3.5 million in 2009 from $675,000 in 2001. The generation skipping tax exclusion will equal the exclusion equivalent in 2004 of $1.5 million and thereafter track its rise to $3.5 million in 2009. And when the federal state death tax credit expires in 2005, many states may rethink their estate and inheritance taxes.
No matter how you say it, the need for life insurance liquidity dollars seemed destined to become history.
Well, don't write off estate liquidity planning with life insurance just yet. What type of planning is right for your clients depends upon what type of assets make-up their estates and what their objectives are with respect to asset accumulation, asset preservation and asset distribution. This is the essence of estate planning. People still feel asset and asset preservation remain primary objectives. How successful they are could depend upon the implementation of one or more life insurance planning strategies:
Liquidity need #1. If a large part of a client's estate is composed of pension or profit sharing assets, IRAs, annuities, non-qualified deferred compensation benefits, vested stock options, unpaid installment sales payments, income taxation alone may preclude attaining estate planning objectives.
Since the Internal Revenue Service classifies these assets as income in respect of a decedent (IRD), they may be subject to estate taxation for the deceased taxpayer/owner and income taxation for the family beneficiaries.
The highest combined marginal estate and income tax bracket rates in 2009 will equal 80% (45% estate/35% income). True, if the one-year estate tax repeal of 2010 becomes permanent then the increased $3.5 million lifetime exclusion per spouse can negate estate tax consequences for most IRD assets. However, estate tax elimination would correspondingly increase the beneficiary's federal income tax liability on these same IRD assets. Currently, any estate taxes paid on IRD assets create an itemized deduction that can be applied against the IRD income received by the beneficiary.
Liquidity need #2. Will the step-up in cost basis for inherited assets to their fair market value be repealed in 2010? That is what the new tax law states. A limited basis step-up is permitted in the new tax act for select non-IRD property ($1.3 million for property transfers and an additional $3 million for qualified spousal property to spousal beneficiaries). Those with low cost basis assets that have grown in value to $5 million, $10 million or $20 million in most cases will need tax-advantaged life insurance assets to offset any capital gains liability and thus avoid the depletion of the capital asset itself. Life insurance assets allow a taxpayer's estate to pay capital gains taxes for "pennies on the dollar."
