It’s commonly known that the best time to go to the zoo is feeding time, when the animals are active, collecting food for themselves and their young ones.
Well, watching how busy fellow financial professionals have been these past several months, I feel like I just got home from a long trip to the zoo. As the end of 2012 drew near, it made for an interesting — if not entertaining and even historic — era for our profession. Not that we are animals, but we sure were active as we stayed busy fulfilling the needs of those who depend on us — our clients.
The end of 2012 meant the end of a two-year period where the estate tax (or death tax) rate was 35 percent with an exemption for estates up to $5 million in value. We saw on the horizon that the tax rate was scheduled to jump to 55 percent this year, with the exemption dropping all the way down to $1 million. As most of you know, while $1 million still sounds like a big number, the reality is that many of our neighbors and clients are fully capable of amassing that type of wealth over a lifetime of work and preparing for retirement — even people who aren’t college educated or who are considered blue collar and/or middle class.
The result was a bit of a zoo-like frenzy, due to the uncertainty of what lay ahead. Clients who had decided to forgo preparing for estate taxes (because they weren’t going to meet the $5 million threshold) saw the impending drop of that threshold to a more pedestrian $1 million and decided they needed to do something.
The truth of the matter is 2012 was all about moving money out of estates to help avoid being slammed with whopping estate tax bills. Hopefully, now that we know the structure of the compromise reached on the estate tax at the beginning of the year, the work of actually thoughtfully preparing for the future will come back and replace the jettison mentality of 2012. And believe it or not, there will be more options.
The trouble with traditional
For the last several years, the most popular and traditional estate tax option hasn’t been all that attractive to people, frankly. This option involved the creation of an irrevocable life insurance trust (ILIT), gifting money from the estate into the trust and having the trust purchase secondary guarantee survivor universal life insurance.
In the era of lower tax rates and $5 million exemptions, this option, while workable, hasn’t been too appealing for a couple of reasons. First of all, it required a commitment to pay premiums until the second death — which could mean decades of monthly payments — even if the first death creates a financial crisis. The surviving spouse is still stuck with a monthly premium bill and wouldn’t be able to access money from the policy, even for burial expenses or other needs. If premiums go unpaid, the policy could be canceled.
Perhaps the most concerning issue from an estate tax preparation standpoint is the fact that survivorship policies are level death benefit policies. While this is fine for a few years, with normal estate value growth and inflation factored in, over many years, the policy value wouldn’t likely be able to keep up with estate value.
With this traditional type of approach, there’s not enough control over external factors like inflation, taxes, health and family status, needs, etc. Even if policyholders keep their end of the bargain and pay premiums until the second death, inflation could make the best of estate planning intentions all for naught. The irony is that the better the client fares in growing the estate, the worse the estate tax situation becomes.
With this type of commitment, mixed with uncertainty and lack of control, it’s no wonder people want to put off addressing their estate issues — often until it’s too late. People like control and certainty. Traditional methods make you lock assets in a box and commit to continue putting money in the box. Period. This is why we all face the challenge of getting people to take action.
The SPO option
One option for 2013 and beyond is to use traditional whole life insurance and attach a survivor purchase option (SPO) rider. This method allows policy owners to have access to their policy cash value and control how they use that capital.