There are many other lucrative planning opportunities that producers can look to

By Daniel J. Munroe

Even the most ardent optimist now has to wonder: Could Congress really pass legislation that permanently repeals the estate tax? One could easily argue that the pro-repeal lobby has never had a better legislative environment in which to work when the 109th Congress reconvenes this month.

After winning the election in November, President Bush stated his desire to make many of his tax cuts in the 2001 Tax Act permanent. The Republican Party also increased its control of Senate seats to 55, up from 51 in the 108th Congress.

But missing from this discussion is how different the world has become since June 2001, when EGTRRA and its curious estate tax repeal were signed into law. Wars stemming from the September 11 terrorist attacks and a growing federal budget deficit suggest that further aggressive tax cuts might be a tough sell. Also to consider is a potentially expensive “fix” of Social Security, a top priority of the president.

The estate tax has been eliminated and revised five times in our nations history. When discussing whether the tax will be “permanently” repealed, I often ask rhetorically whether the Democrats could once again take the White House and gain a majority in the House and Senate. If so, what are the chances of an estate tax reappearing?

So, while members of the insurance industry wring their hands in anxiety over repeal, we might do well to focus on the many lucrative planning opportunitiesseparate from the estate taxto assist clients in the accumulation, distribution and transfer of their wealth.

The New Basis Regime

A widely unknown provision in the 2001 Tax Act may have a significant and unexpected income tax liability for clients. Currently, the basis in personal or real property is “stepped-up” at the owners death. This would change in 2010, when the estate tax is scheduled for a full repeal.

In that year, apart from a general aggregate allowance of $1.3 million and an additional allowance of $3 million for certain transfers to surviving spouses, the basis of an asset would no longer generally be stepped-up. Rather, the original basis of the asset would carry over, or pass to the beneficiary with the same basis as the original owner.

Where the estate needs to sell appreciated assets to pay estate expenses or facilitate distribution of the estate, proceeds from a life insurance policy covering the decedent may enable the estate to pay the increased income taxes caused by use of a carryover, instead of a fair market value basis.

Inheritance Equalization

Life insurance is an efficient vehicle through which to equalize an inheritance among a group of beneficiaries. For example, lets assume a business owner has three children: Two are involved with the family business and one is a struggling actor. Nearly all of the owners wealth is tied up in the family business so that, at her death, the struggling actor would receive virtually no inheritance. A life insurance policy can help ensure the actor receives an inheritance.

Credit Shelter Trust Planning

A unique planning opportunity uses the existing funded credit shelter trust to purchase life insurance, thereby leveraging the inheritance to beneficiaries. For example, suppose a husband and wife created “A-B” wills several years ago. The husband recently passed away; his credit shelter or “B” trust now is funded with $1 million of cash, mutual funds and individual stocks.

The wife has sufficient assets apart from the credit shelter trust to support her and would like to leave as large an estate as possible to her children and grandchildren. Under certain circumstances, all or a portion of the credit shelter trust assets may be used to purchase life insurance on her life.

The credit shelter trusts remainder beneficiaries will receive the proceeds income tax and estate tax-free. Assets the surviving spouse owned at her death, apart from those in the credit shelter trust, may be subject to estate taxes. The surviving spouse must not have incidents of ownership in the policy under IRC Sec. 2042.

A clients attorney should be sure this planning strategy is viable. The authority to purchase life insurance is often found in the section of the trust document outlining the trustees powers.

Equally important, the insured cannot possess incidents of ownership over the policy. Therefore, the insured cannot serve as trustee of a trust owning life insurance on her life. If serving, the surviving spouse will have to resign prior to purchasing the policy to avoid the application of the 3-year pullback rule.

The attorney also should be sure the surviving spouse does not have a general power of appointment. This power would cause inclusion of the proceeds to be taxed in the surviving spouses estate because of the incidents of ownership rule.

If done within 9 months from the deceased spouses date of death, this power may be disclaimed or released if, after this time, state law allows. A well-drafted trust can avoid the need for postmortem planning by carving out the life insurance from the power of appointment. Many advanced sales departments can assist producers with this sales strategy by reviewing trusts and consulting with a clients attorney.

Retirement Planning

As baby boomers continue to retire in record numbers over the next 20 years, the desire for retirement planning has never been in greater demand. Life insurance may assist clients in accomplishing their retirement goals.

For many, Social Security, qualified plans and a securities portfolio may be insufficient to realize a retirement income sufficient to support a desired lifestyle. Life insurance may offer an additional solution to death benefit and supplemental retirement planning needs.

Employee benefit plans, such as profit-sharing plans, plus Sections 412(i) and 419A(f)(6) plans, may use life insurance as underlying funding vehicles. These plans let clients purchase a policy in a tax-efficient manner.

Recent legislation has clarified the requirements of nonqualified deferred compensation plans, thereby giving clients more certainty in setting up and funding their plans. Using life insurance to “informally fund” these plans allows many options for both the employer and the executive.

With life insurance, the employer might choose a cost recovery program to get “paid back” at the participants death. In addition, the employer may avoid paying current taxes on the income tax-free buildup in a life insurance policy. The executive enjoys both a death benefit for his beneficiaries, as well as the ability to defer taxes until some conditional future date.

Wealth Transfer

Many successful producers continue to educate clients on the value of life insurance for wealth transfer purposes. Clients who wish to pass on a certain amount of money at death often are surprised to learn about the power of life insurance in leveraging that money for a greater inheritance. The sales idea of selling life insurance by using “pennies on the dollar” will never go out of style, regardless of the estate taxs future.

Business Planning

Small business owners can solve many needs through life insurance. The fact that such a small percentage of family-owned businesses fail to continue to the next generation demonstrates the great need for business succession planning.

Offering a cross-purchase or stock redemption arrangement funded with life insurance can help ensure a business is properly transferred from one owner to the next. Businesses also have key executives who would be difficult to replace. A life insurance policy covering their lives makes finding and hiring new leadership much easier.

Income Replacement

Of course, the traditional strategy of using life insurance to replace future income survives with or without the estate tax. Income replacement for needs including funeral expenses, debts and maintaining family standard of living, to name a few, are all critical to families.

While a popular sales strategyselling life insurance to pay for estate taxesmay be in jeopardy, the prospect of estate tax repeal is not the end of the world for producers. And many other sales concepts exist to help clients realize their accumulation, protection, income and transfer needs.

Daniel J. Munroe, JD, CLU, is director of advanced marketing at MONY Partners, Hartford, Conn. He may be reached at dmunroe@mony.com.


Reproduced from National Underwriter Edition, December 30, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.