Because of the still relatively new estate tax regime, some factors and tools of estate planning need to be looked at differently than before. Here’s the first area we’ll review…
Life insurance. Traditionally the main reason to buy permanent life insurance was to help pay for estate taxes.
The number of people with that need is reduced, but that doesn’t mean you should ignore life insurance.
There are other ways of using life insurance that can be more valuable now, and some strategies that weren’t wise under the old law now make more sense.
Permanent life insurance has an investment component.
Earnings of the policy’s cash value compound tax deferred as long as they remain in the policy.
In addition, after the earnings compound for some period of years, loans can be taken from the cash value.
The loans are tax free and don’t need to be repaid during life as long as the cash value is sufficient to help pay premiums or you’re willing to make additional premium payments to maintain the minimum ratio between cash value and life insurance benefits.
Any outstanding loans eventually are subtracted from the death benefits, reducing the amount available to heirs.
Higher income tax rates make life insurance as an investment vehicle more attractive.
To some people, they’re even more attractive because of the higher estate tax exemption.
Under the pre-2010 law, many people avoided owning policies, because the benefits would be included in their estates and potentially subject to estate taxes.
The higher estate tax exemption means fewer people have to worry about the estate tax reducing the insurance benefits.
They can own and control the policies, and have access to the cash value for life.
If their estates are exempt from estate tax, the heirs receive the full benefits, minus any loans, free of estate and income taxes.
Borrowing from insurance cash value isn’t risk free.
Many people who took out policies in the 1990s and early 2000s found that because of low interest rates their policy cash values didn’t generate enough income to keep the policies in force without significant new premium payments.
If you plan to use life insurance as an investment vehicle, you need to work with a knowledgeable broker or agent who will be sure you’re fully apprised of the risks and knows how to manage those risks and the policy.
The new law also makes life insurance more attractive in employer retirement plans (they aren’t allowed in IRAs and some other retirement plans).
Buying the insurance through a pension plan means tax deductible dollars are used to make the purchase, and the insurance benefits should be more than the premiums paid.
Estate planners often advised against the strategy in the past because the life insurance would be included in the estate.
With the higher estate tax exemption, however, fewer people need to worry about the estate taxes and can focus on the benefits of owning life insurance through a retirement plan.
Another change: It used to be routine that substantial life insurance policies would be held in trusts to ensure the benefits weren’t included in the taxable estate.
With the high estate tax exemption, there is less need for incurring the expense and inconvenience of a trust.
Many people now can own the policies themselves and still be confident the full policy value will be available to pay estate taxes or debts or enhance the inheritances of their loved ones.
In next week’s issue, we’ll discuss some more areas that have been affected by the ever-changing estate planning landscape. But until then, you can consult my monthly newsletter, Retirement Watch, for more updates and recommendations.