5 New Opportunities For Life Insurance Planning Strategies
James Madison, our fourth president and a leading political theorist, postulated in the Federalist Papers that if tax law is too verbose it will not be read and it if is too long it will not be understood.
Too bad no one took his advice. The U.S. Tax Code has since grown to 25 volumes with more than 45,000 pages. The documents required to explain the Code are four times as long as the Code itself. Congress further padded those volumes in 2001 when it passed the Economic Growth Tax Reform & Reconciliation Act (EGTRRA) with more than 300 changes in gift, estate and income tax laws.
As the industry has seen over the past year, these changes created a good deal of uncertainty and instability for those trying to create long-term financial plans. But these changes also opened the door to four new life insurance-oriented strategies to address liquidity needs, plus a new estate-planning strategy.
Life Insurance Need #1. Although EGTRRA repealed the federal estate tax in 2010, sunset provisions reinstate the tax as well as the top marginal rate of 55% on Jan. 1, 2011. Only the estates of those who die in 2010 will avoid the federal estate tax. Whatever future changes may occur in estate tax law, a properly designed life insurance plan can promote wealth preservation. The death benefits from a life insurance policy can be used to pay the estate tax for “pennies on the dollar.”
Life Insurance Need #2. EGTRRA capped lifetime gifts at $1 million. If a taxpayer decides to fund a lifetime credit shelter trust in 2004, with $1.5 million–the amount equal to the then available death-time exclusion–he or she would trigger a $210,000 federal gift tax.
This is a dilemma for planners and taxpayers because it is generally more efficient to transfer property during life than at death. After all, lifetime gifts allow the donor to remove all future asset growth from estate taxation.
The following strategies can be used to neutralize and counter the $1 million EGTRRA gift tax exclusion on lifetime transfers:
(1) Multiply the tax-free annual exclusion gifts of a present interest to a trust by the number of potential beneficiaries named and give each beneficiary a limited amount of time to withdraw the donors gift to the trust.
(2) Spousal gift splitting allows a spouse to apply his or her exclusion/exemption to property owned and gifted by the other spouse.