In the days before the current Bush Administration enacted its controversial plan to phase out and ultimately repeal the federal estate tax, it was a foregone conclusion for advisors working with high-net-worth clients to suggest some form of second-to-die (survivorship) life insurance as a means of protecting assets and generating liquidity to pay estate taxes.
Much has changed in estate planning circles as a result of the Economic Growth and Tax Relief Reconciliation Act of 2001, however. Because federal estate tax exemption levels have been rising while the highest federal estate tax rates have been falling, a perception has emerged that people no longer need a life insurance policy as a tax-advantaged estate planning tool because their overall federal estate tax liability will diminish or disappear altogether over time. And that will indeed be the case, at least for one year (2010), assuming Bush's plan remains intact.
However, such a perception fails to account for the possibility – and according to many astute observers, the probability – that the current plan will be restructured or replaced sometime in the not-too-distant future. Nor does it account for recent changes in state estate tax policies prompted by EGTRRA. Where states once uniformly followed Uncle Sam's lead with regard to estate tax policies, since 2001 many have opted to decouple their estate tax schemes from the federal plan. New Jersey, for example, froze its estate tax exemption at 2001 levels rather than follow Uncle Sam. Today, an estimated 15 to 20 states have moved to decouple their estate tax schemes.
Amid so much flux and uncertainty, life insurance is no less vital as an estate-planning instrument today than it was five years ago, according to advisors who specialize in wealth-transfer and asset-protection strategies for seniors. The advantages that life insurance offers to clients who want to preserve a financial legacy – the ability to protect assets from taxation when they pass from one generation to the next, plus the ability to invest discounted dollars to ensure beneficiaries (heirs) have enough liquidity to cover estate taxes, without depleting the estate – are as valid in 2006 as they were in 2001.
"You would be hard-pressed," says Certified Financial Planner Randolph J. Shine of Shine Financial in Deerfield Beach, Fla., "to find a better investment than life insurance to preserve or increase family wealth on a tax-favored basis."
Where there's a need
Life insurance has obvious value as an estate planning tool for high-net-worth clients whose estates are so large they still carry potential tax exposure, despite year-to-year increases in the federal estate tax exemption. The decoupling of state and federal estate tax policies, and the additional estate tax liability clients in "decoupled" states potentially face, is another reason advisors like Scott L. Harris, CLTC, continue to steer clients toward life insurance in an estate planning context.
Harris, an insurance specialist for the Carta Group in Syracuse, N.Y., finds himself in just such a position, with his home state among those to have decoupled its estate tax scheme following implementation of the federal repeal plan. For some clients with sizable estates, the federal phase-out giveth and it taketh away. In states that reacted to the Bush plan by decoupling their estate tax schemes, clients now may face state estate tax liability, even though the higher federal exemption levels mean they have no such liability to Uncle Sam.
As a result, explains Harris, "We're telling our clients not to ignore the estate tax on the state side. We are seeing more states decouple as they look for ways to generate revenue. That's going to be a troublesome issue – and one that demands that we remain flexible. Flexibility is one of the strong points of life insurance used for estate planning."
Today, as in the days before the current plan, among the most popular uses for a life insurance policy within an estate plan is to generate proceeds to cover estate tax liability. Investing in an insurance policy "buys the ability to conserve family assets in meeting tax liabilities," Shine explains. As a rule of thumb, one purchases a policy with a death benefit that's large enough to cover those liabilities, he says.
But covering an estate tax tab isn't the only valid reason for a senior to buy life insurance as one component of an estate plan. Buying an insurance policy also can help clients reduce liabilities in other areas of their tax ledger, according to Certified Financial Planner Sally Jo Button, principal at Button Financial in Lakewood, Colo. For example, she says, clients who own an annuity as a nonqualified asset may face significant tax liability having that annuity as part of their estate, particularly if the annuity contract has performed well on an income basis and the client has had it for a long period of time.
