Does the scheduled repeal of the estate tax make permanent, cash value life insurance obsolete? Some financial advisers think that if the estate tax’s days are numbered, few people need life insurance. Others say nothing has changed. The truth is somewhere in between.
Let’s review some of the reasons why you don’t want to automatically drop life insurance from the estate planning toolbox.
The estate tax won’t be repealed until 2010. Then, unless the law changes, the tax will be reinstated in 2011. So, repeal is a few years away and might be reinstated.
In addition, when full repeal takes effect, the step-up in basis rules will be repealed. The step-up rules provide that when property is inherited, the tax basis gets increased to the current fair market value. The inheritor can sell the property immediately and recognize no capital gain. All the appreciation during the previous owner’s lifetime escapes capital gains taxes. But after 2009, many inheritors won’t get the benefit of stepped-up basis. Estate taxes might be avoided, but there could be substantial capital gains taxes on property sold by heirs.
While life insurance frequently is used to pay estate taxes, there are reasons other than taxes to consider adding life insurance to your estate plan.
Your estate might need cash to pay debts or expenses, especially if you own illiquid assets such as a business or real estate. Life insurance also can be used to equalize inheritances. You might leave a business or real estate only to the children who are interested in managing it. If so, life insurance is the way to provide for the other children.
You also might want to protect your loved ones from the financial consequences of your premature death by using life insurance to ensure the debts will be paid or your children will have the money to attend college. This function, though, often is best served by term life insurance instead of cash value policies.
Some people buy permanent life insurance to increase an estate. Often the benefit from a life insurance policy will greatly exceed the total lifetime premiums paid. If you have extra income, buying life insurance can increase your estate faster than investing the money.
Insurance also is useful for business buy-out plans if you have co-owners or as part of a deferred compensation plan for executives.
Asset protection from creditors is another use of permanent life insurance. Creditors in most states cannot get access to the cash value of a debtor’s life insurance.
Suppose you aren’t interested in the non-tax reasons for permanent life insurance. In that case, when should you consider purchasing insurance to pay taxes? In the wake of estate tax reform, we have to look at the situation a bit differently than in the past. Consider not only the size of your estate but also both the likelihood of further changes in the estate tax law and your longevity.
Of course, remember life insurance is part of an estate plan, not an estate plan. Most of all, in all your planning remember to retain some flexibility. Much can happen between now and 2010.